1922 


mm 


DEPRECIATION  CHARGES 

OF  RAILROADS  AND 

PUBLIC  UTILITIES 


A  Memorandum  Filed  with  the 

Depreciation  Section  of  the 

Bureau  of  Accounts 

OF  THE 

Interstate  Commerce  Commission 


By 

ROBERT  A.  CARTER, 

Chairman  of  the  Committee  on  Rate 

Fundamentals  of  the  American 

Gas  Association;  and 

WILLIAM  L.  RANSOM 
of  the  New  York  Bar. 


(Reprinted,  with  Additional   Notes,  March  10,  1922) 


A.  W.  Stevens,  300  Washington  Street,  Brooklyn,  N.  Y 


^fcfj 


.. 


INDEX 

PAGE 

Reasons  for  Interest  in  Subject 1 

Effect  of  Increased  Railroad  Rates  on 
Costs  of  Utility  Service  in  New  York 
City 2-5 

Pertinent    Provisions    of    the    Interstate 

Commerce  Act 5-7 

Purposes  of  the  Statute  Analyzed 7-9 

Nature  of  "Depreciation  Charges"  as  to 

Railway  Property 9-13 

The    Sound    Treatment    of    "Retirement 

Expense" 14-18 

Analysis  of  the  "Depreciation  Charges" 

of  Railway  Carriers  Since  1912 18-23 

Concrete    Recommendations    as    to    the 

Handling  of  "Depreciation  Charges"     23-24 

The  Two  Opposing  Views  as  to  Provisions 

for  the  Upkeep  of  Property 2^-26 

Decisions  of  the  Courts  and  Regulatory 
Commissions  Concerning  These  Op- 
posing Views 26 

The  New  York  and  Queens  Gas  Co. 

Case 26-32 

Consolidated  Gas  Co.  vs.  Neivton  (267 

Fed.  231)  32-37 

New  York  and  Richmond  Gas  Co.  vs. 

Nixon 38 

The  Nashville,  C.  &  St.  L.  Ry.  Co. 

Case 38-45 


11. 

PAGE 

The  Rulings  of  the  Department  of  In- 
ternal Revenue 45-46 

The  Kansas  District  Court  Rejects  "The- 
oretical Depreciation" 46-47 

The  Recent  Decision  in  the  Pacific  Gas  & 

Electric  Co.  Case 47-50 

Basis    of   the    1920   Grant   of   Increased 

Freight  Rates 51-53 

The  Knoxville  Water  Co.  Case 53-55,  57-67 

The  Minnesota  Rate  Case 55-56 

The  Kansas  City  Southern  Ry.  Co.  Case. . 

65-66,  9&-100 

The  First  Consolidated  Gas  Co.  Rate  Case    66-72 

Oklahoma    and    Pennsylvania    Decisions 

Cited  as  Adverse  Authority 75-79 

Essential  Purposes  of  the  Statute  and  the 
Relation  of  " Depreciation  Charges" 
Thereto 79^-81 

Reasons  Why  the  Cost  of  Retirements 
Should  Not  Be  Anticipated  Through 
Accruals  Based  on  "Life  Tables". . .     81-83 

Concrete  Illustration  of  the  Reasons  Why 
the  Rate  Should  Not  Be  Burdened 
With  Charges  Anticipating  Future 
Retirements 83-86 

The  "Woodpile"  and  " Fleet-of -Taxi- 
cabs"  Illustrations  *.     86-98 

Other  Decisions  of  Courts  and  Commis- 
sions    100-108 


111. 

PAGE 

Summary  of  Conclusions  From  the  Fore- 
going Decisions 108 

Basic  Objections  to  the  "Accrued  Depre- 
ciation" Theory 109-111 

The  Brooklyn  Borough  Gas  Co.  Case  and 

Other  Eecent  New  York  Kulings 112-116 

In  Conclusion 116-118 


TABLE    OF    CASES 

PAGE 

Amherst  vs.  Snyder    Gas    Co.  (P.  U.  R. 

1921  D,  page  540)    115 

Ben  Avon  Borough  vs.  Ohio  Valley  Water 
Co.  (P.*U.  R.  1918  A,  page  161;  see, 
also,  253  U.  S.  287)  7&-79 

Bonbright  vs.  Geary  (210  Fed.  44) 72-74 

Brooklyn  Borough  Gas  Co.  vs.  Pub.  Serv. 
Comn.  1st  Dist.  (17  N.  Y.  St.  Dept. 
Repts.,  page  81)  112-114 

Consolidated  Gas  Co.  vs.  Newton  et  al. 

(267  Fed.  231 ;  — U.  S.— )  26,  32-36,  63,  66,  87 

Consolidated   Gas   Co.   vs.   City  of   New 

York  (157  Fed.  849)  71 

Contra  Costa  Water  Co.  vs.  City  of  Oak- 
land (113  Pac.  668)  47-50 

Cumberland  Telephone  &  Teleg.  Co.  vs. 
City  of  Louisville  (157  Fed.  637,  650; 
212  U.  S.  414)  74-75 

Ex  Parte  74  (Before  Interst.  Com.  Comn.)     23,  24 

Havre  de  Grace  &  P.  Bridge  Co.  vs.  Tow- 
ers (103  Atl.  319;  P.  U.  R.  1918  D, 
page  484)    100-102 

Hoffman  vs.  Elmira  Water,  Light  &  R.  R. 
Co.  (P.  U.  R.,  1920  D,  page  266;  P.  U. 
R.  1921  C,  page  409 ;  N.  Y.,  2nd  Dist.)        115 

Kansas  City  Southern  Ry.  Co.  vs.  XL  S. 

(231  U.  S.  423) A3, 17, 60,  65-66,  98-100 

Knoxville  Water  Co.  vs.  Knoxville  (212 

U.  S.  1)   ...  .36,  53-55,  56,  57-64,  66,  73,  98-99 

Landon  vs.  Court  of  Industrial  Relations 

(269  Fed.  433,  445)  46^47 


V. 

PAGE 

Lincoln  Gas  Co.  vs.  Lincoln   (223  U.  S. 

349)  56 

Milwaukee  El.  Ry.  &  L.  Co.  vs.  Milwaukee 

(P.  U.  R.  1918  E,  page  1 ;  Wise.) ....  105 
Minnesota  Rate  Case  (230  U.  S.  352)  .  .36,55-56 
Murray  vs.  Public  Utilities  Comn.   (150 

Pac.  57;  P.  U.  R.  1915  F,  page  436) .  .102-104 
Nashville  C.  &  St.  L.  Ry.  Co.  vs.  U.  S. 

(269  Fed.  351)   38-45 

New  York  &  Richmond  Gas  Co.  vs.  Nixon  38 

New  York  and  Queens  Gas  Co.  vs.  Newton 

et  al  (269  Fed.  277 ;  —IT.  S.— ) .  .26-32,  61,  87 
Pacific  Gas  &  Electric  Co.  vs.  San  Fran- 
cisco (273  Fed.  937;  U.  S.  Dist.  Ct; 

No.  Dist.  of  Cal.) 26, 48-50 

People  ex  rel.  N.  Y.  Rys.  Co.  vs.  Pub.  Serv. 

Comn.  (223  N.  Y.  373) 112 

Pioneer  Telephone  &  Telegraph  Co.  vs. 

Westenhaver  (29  Okla.  420) 75-78 

Pioneer    Telephone   &   Telegraph  Co.  vs. 

State  of  Oklahoma  (167  Pac.  995) ....  75-78 
Public  Service  Comn.  of  Washington  vs. 

Kelso  Water  Co.  (P.  U.  R.  1919  E, 

page  206)    106-107 

Public  Service  Comn.  of  Washington  vs. 

Pacific  Power  &  Light  Co 105-106 

Re  Arkansas  Light  &  Power  Co.  (P.  U.  R. 

1920  D,  page  775 ;  Ark.) 107-108 

Re  Binghamton  Light,  Heat  &  Power  Co. 

(24  N.  Y.  St.  Dept.  Repts.,  page  651)  114-115 
Re  Campbell  Bros.  Water  Co.  (Idaho  P. 

S.  Comn. ;  February  25,  1921)   104 

Re  Gardiner  Electric  Lt.  &  Water  Co.  (P. 

U.  R.  1920  D,  page  821 ;  Mont.) 108 

Re  Increased  Freight  Rates  (58  I.  C.  C. 

220)  51-53 


VI. 

PAGE 

Ee  Medford  Gas  Co.  (P.  II.  R.  1919  E, 

page  707;  N.  J.)  105 

Re    Mineral    Point    Public    Service    Co. 

(P.  U.  R.  1919  A?  page  795 ;  Wise.) ...         105 

Re  New  York  State  Railways  (P.  U.  R. 

1921  C,  page  496;  N.  Y.,  2nd  Dist.) . .         115 

Re  Pocatello  Water  Co.  (P.  U.  R.  1915  F, 

page  436 ;  Idaho)  95 

Re  Rates  of  Katonah  Lighting  Co.  (Pub. 

Serv.  Comn.,  N.  Y.)   116 

Re  Wood  River  Power  Co.  (P.  U.  R.  1921, 

page  531;  Idaho)    103-104 

Sandpoint   vs.   Sandpoint  W.   &.   L.    Co. 

(P.  U.  R.  1915  F,  page  464;  Idaho) . .        102 

Spring  Valley  Water  Co.  vs.  San  Fran- 
cisco (252  Fed.  979) 47-50 

Willcox  vs.    Consolidated    Gas   Co.    (157 

Fed.  849;  212  U.  S.  19)  66-72 


130  EAST  FIFTEENTH  STREET 

New  York  City 

Honorable  Frank  S.  Fowler, 
Chief  of  the  Depreciation  Section, 
Bureau  of  Accounts, 
Interstate  Commerce  Commission, 
Washington,  D.  C. 

Dear  Sir: 

This  memorandum,  in  letter  form,  is  submitted 
by  way  of  compliance  with  your  courteous  com- 
munication of  March  2, 1921,  in  which  you  stated 
that  for  the  purposes  of  the  investigations  pre- 
liminary to  the  performance  of  the  duties  de- 
volved upon  the  Interstate  Commerce  Commission 
by  Section  20  of  the  Interstate  Commerce  Act  as 
amended,  the  Bureau  of  Accounts  will  be  glad  to 
receive  an  informal  submission  of  the  views  of 
those  especially  interested  in  the  subject  of  depre- 
ciation. I  have  asked  Ex-Justice  William  L.  Han- 
som, of  counsel  for  some  of  the  companies  in 
which  I  am  interested,  to  co-operate  with  me  in 
the  preparation  of  this  memorandum,  particularly 
in  so  far  as  it  deals  with  the  construction  of  stat- 
utes and  the  decisions  of  Courts  and  regulatory 
tribunals. 

First  let  me  say  a  word  as  to  my  reasons  for 
interest  in  this  subject,  to  which  I  have  devoted 
thought  and  study  for  many  years.  My  interest 
in  the  subject  is  neither  academic  nor  speculative. 
Consideration  of  its  practical  aspects  is  forced 
upon  me  by  the  incidents  of  almost  every  day  of 
my  business  activity.     Error  on  the  part  of  the 


Interstate  Commerce  Commission,  in  making  the 
classifications  and  regulatory  requirements  speci- 
fied in  paragraph  5  of  Section  20  of  the  Inter- 
state Commerce  Act  as  amended,  would  have  seri- 
ous consequences,  both  to  the  many  investors  in 
the  companies  of  which  I  am  an  executive  or  di- 
rector, and  to  the  many  patrons  whom  those  com- 
panies desire  to  serve  economically  and  well. 

These  companies  with  which  I  am  connected 
furnish  heat,  light,  fuel  and  power  for  the  daily 
requirements  of  many  millions  of  people.  The 
total  quantity  of  gas  sold  by  the  Consolidated 
Gas  Company  and  its  affiliated  companies  in  1919 
was  33,674,972,000  cubic  feet.  Its  affiliated  electric 
companies  sold  in  1919,  865,388,322  kilowatt  hours 
of  electric  energy.  As  of  April,  1920,  the  total 
number  of  customers  relying  upon  the  Consoli- 
dated Gas  Company  and  its  affiliated  gas  and 
electric  companies  for  their  needs  for  heat, 
light,  fuel  and  power,  was  1,409,774.  Families 
depend  on  gas  and  electricity  for  cooking,  heating, 
lighting  and  other  domestic  uses ;  included  in  the 
list  of  consumers  are  countless  factories,  shops, 
hotels,  stores,  theaters,  and  other  industrial  and 
commercial  enterprises,  on  which  several  millions 
of  people  depend  directly  for  livelihood.  The  in- 
dustrial and  commercial  success  of  the  splendid 
territory  served  by  these  companies  demands  the 
furnishing  of  good  service  at  the  lowest  rates  con- 
sistent with  the  maintenance  of  that  quality  of 
service  and  the  earning  of  a  fair  return  on  the  cap- 
ital investment  It  is  not  too  much  to  say  that  the 
furnishing  of  gas  and  electric  energy  in  adequate 
quantities  and  at  rates  no  higher  than  necessary 
for  the  defraying  of  operating  expenses  and  the 
earning  of  a  reasonable  return  upon  the  invested 
capital,  is  probably  the  single  service  most  essen- 


tial  to  the  convenience,  comfort,  health  and  life 
of  the  inhabitants  of  the  City  of  New  York  and 
adjacent  territory  served  by  these  companies,  and 
to  the  continuance  and  prosperity  of  the  business 
enterprises  carried  on  therein. 

We  desire  greatly,  in  the  first  place,  to  furnish 
an  efficient  and  acceptable  service  to  all  our  con- 
sumers and  patrons,  and,  in  the  second  place,  to 
charge  them  a  rate  no  higher  than  is  absolutely 
necessary  to  reimburse  us  for  operating  expendi- 
tures actually  made  and  yield,  in  addition,  a  fair 
return  on  our  actual  investment  as  judicially  es- 
tablished. We  adhere  to  that  standard  in  the  fixa- 
tion of  the  rates  charged  by  our  companies;  we 
desire  that  railroads  and  regulated  utilities  whose 
service  we  require  in  the  carrying  on  of  our  busi- 
ness, shall  do  the  same  thing.  The  amount  of 
money  which  we  have  to  pay  out  for  freight  rates 
becomes  a  large  item  in  our  operating  costs;  and 
we,  in  turn,  as  patrons  of  railway  service,  do  not 
wish  to  pay  excessive  rates  or  rates  inflated  by 
fictitious  charges,  in  the  guise  of  operating  ex- 
penses or  anything  else. 

In  the  production  of  these  great  quantities  of 
gas  and  electric  energy  and,  to  a  lesser  extent,  in 
transmitting  the  same  from  the  manufacturing 
and  generating  plants  to  the  premises  of  myriad 
consumers,  there  is  required  the  consumption  and 
use  of  vast  quantities  of  coal,  oil  and  other  mate- 
rials, all  of  which  coal,  and  a  large  part  of  which 
other  materials  are  necessarily  transported  for 
greater  or  lesser  distances  over  the  lines  of  rail- 
road common  carriers  operating  in  interstate  com- 
merce within  the  boundaries  of  the  United  States, 
for  which  transportation  the  Consolidated  Gas 
Company  and  its  affiliated  gas  and  electric  com- 
panies pay  annually  large  and  increasing  sums  of 


money  in  freight  charges,  the  total  of  such  charges 
paid  by  them  and  charged  to  their  operating  ex- 
penses amounting,  on  coal  alone,  during  the  year 
1919,  to  not  less  than  $3,967,422.00,  and  to  a  sub- 
stantially greater  sum  in  1920.  During  the  calen- 
dar year  1919  there  were  delivered  by  rail  trans- 
portation 798,937  gross  tons  of  coal  to  these  affili- 
ated gas  companies  and  1,008,312  gross  tons  to 
the  affiliated  electric  companies,  a  total  of  more 
than  1,800,000  tons  of  coal,  all  of  which  was  used 
in  the  generation  and  distribution  of  gas  and  elec- 
tricity during  1919.  The  quantity  used  in  1920 
amounted  to  more  than  2,200,000  tons.  By  reason 
of  the  foregoing,  the  gas  and  electric  industry 
conducted  by  the  Consolidated  Gas  Company  and 
its  affiliated  companies  has  been  and  is  one  of 
the  largest  patrons  of  railroad  transportation  in 
the  United  States. 

In  the  construction  of  new  plant,  the  installation 
of  additions  to  apparatus  and  equipment,  the  re- 
pair and  upkeep  of  structures  and  apparatus,  the 
making  of  replacements  and  extensions  of  the  dis- 
tributing systems,  and  the  like,  there  is  required 
the  use  of  large  quantities  of  brick,  cement,  steel, 
brass-work,  iron  pipe,  and  other  materials,  upon 
which  the  freight  charges  amount  to  many  thou- 
sands of  dollars  annually,  which  freight  charges 
add  greatly  to  the  annual  cost  of  the  maintenance, 
repair  and  upkeep  of  the  properties  of  these  affili- 
ated companies  in  their  continued  high  state  of 
operating  efficiency,  and  add  substantially  to  the 
cost  of  the  new  construction,  which,  in  turn,  be- 
comes a  part  of  the  necessary  investment  of  the 
companies  in  property  required  for  the  carrying 
on  of  the  gas  and  electric  business,  upon  which 
the  consumers  must  pay  a  rate  yielding  a  fair  re- 
turn from  year  to  year. 


5 

By  reason  of  the  effect  on  both  our  operating 
expenses  and  our  required  investment,  we  feel 
that  we  are  directly  and  actually  interested  in 
seeing  to  it  that  the  burden  of  the  charges  of  rail- 
road common  carriers  for  the  transportation  of 
coal,  oil,  brick,  cement,  iron,  steel,  pipe  and  other 
materials  in  interstate  commerce,  shall  be  and  be 
kept  no  greater  than  is  from  time  to  time  reason- 
ably necessary  to  pay  the  actual  cost  of  the  rend- 
ering of  adequate  and  efficient  service  by  such 
common  carriers  and  the  maintenance  and  upkeep 
of  their  property  in  first  class  operating  condition, 
and  to  pay  a  reasonable  return  upon  their  in- 
vested capital.  That  interest  leads  to  the  prepa- 
ration and  filing  of  this  memorandum. 

The  Pertinent  Provisions  of  the  Statute 

Turning  to  the  particular  statutory  duty  of  the 
Interstate  Commerce  Commission  under  discus- 
sion, it  may  be  noted  that  Section  15a,  paragraph 
2  of  the  Interstate  Commerce  Act,  as  amended,  re- 
quires that  the  rates  of  carriers  by  railroad  be  so 
adjusted  that  the  said  carriers 

"*  *  *  will,  under  honest,  efficient  and  eco- 
nomical management  and  reasonable  expen- 
ditures for  maintenance  of  way,  structures 
and  equipment,  earn  an  aggregate  annual 
net  railway  operating  income  equal  as  near- 
ly as  may  be  to  a  fair  return  upon  the  ag- 
gregate value  of  the  railway  property  of 
such  carriers  held  for  and  used  in  the  ser- 
vice of  transportation ;" 

and  Paragraph  3  of  the  same  section  provides 

"that  during  the  two  years  beginning 
March  1, 1920,  the  Commission  shall  take  as 
such  fair  return  a  sum  equal  to  5y2  per 
centum  of  such  aggregate  value,  but  may, 
in  its  discretion,  add  thereto  a  sum  not  ex- 


ceeding  one-half  of  one  per  centum  of  such 
aggregate  value  to  make  provision  in  whole 
or  in  part  for  improvements,  betterments 
or  equipment,  which,  according  to  the  ac- 
counting system  prescribed  by  the  Commis- 
sion, are  chargeable  to  capital  account" ; 

while  Paragraph  1  of  the  same  section  defines  the 
term  "net  railway  operating  income"  as 

"railway  operating  income,  including  in 
the  computation  thereof  debits  and  credits 
arising  from  equipment  rents  and  joint 
facility  rents." 

The  term  "railway  operating  income"  has 
seemed  to  us  to  be  used  in  the  statute  in  obviously 
the  same  sense  as  in  the  accounting  system  pre- 
scribed by  the  Commission;  namely,  to  denote 
any  excess  of  railway  operating  revenues  over 
railway  operating  expenses. 

Section  20,  paragraph  5,  of  the  Interstate  Com- 
merce Act  directs  that 

"The  Commission  shall,  as  soon  as  prac- 
ticable, prescribe,  for  carriers  subject  to 
this  Act,  the  classes  of  property  for  which 
depreciation  charges  may  properly  be  in- 
cluded under  operating  expenses,  and  the 
percentages  of  depreciation  which  shall  be 
charged  with  respect  to  each  of  such  classes 
of  property,  classifying  the  carriers  as  it 
may  deem  proper  for  this  purpose.  The 
Commission  may,  when  it  deems  necessary, 
modify  the  classes  and  percentages  so  pre- 
scribed. The  carriers  subject  to  this  Act 
shall  not  charge  to  operating  expenses  any 
depreciation  charges  on  classes  of  property 
other  than  those  prescribed  by  the  Com- 
mission, or  charge  with  respect  to  any  class 
of  property  a  percentage  other  than  that 
prescribed  therefor  by  the  Commission.  No 
such  carrier  shall  in  any  case  include  in  any 


form  under  its  operating  or  other  expenses 
any  depreciation  or  other  charge  or  expen- 
diture included  elsewhere  as  a  depreciation 
charge  or  otherwise  under  its  operating  or 
other  expenses." 

Purposes  of  the  Statute  Analyzed 

The  purpose  of  the  prohibition  contained  in  the 
sentence  last  quoted  above  has  seemed  to  us  to 
be  obviously  the  prevention  of  excessive  or  im- 
proper charges  to  expense  accounts  through  du- 
plicated charges,  and  the  purpose  of  the  provi- 
sions respecting  the  so-called  "depreciation 
charges"  is  to  keep  them  whithin  reasonable 
bounds.  The  necessity  for  strict  scrutiny  and  reg- 
ulation by  the  Commission  in  this  regard  appears 
clearly  when  it  is  considered  that  the  net  rail- 
way operating  income,  which  the  statute  directs 
shall  be  kept  large  enough  to  yield  for  the  car- 
riers of  a  rate  district  a  fair  annual  return  on  the 
aggregate  value  of  the  property  devoted  to  rail- 
way service,  is  in  turn  dependent  on  the  railway 
operating  income,  which  is  what  is  left  after  de- 
ducting railway  operating  expenses  from  railway 
operating  revenues.  In  order  that  the  schedules 
of  railway  rates  at  a  given  time  in  force  may  not 
wrongly  be  made  to  appear  to  yield  an  insufficient 
net  operating  income,  and  so,  because  of  inflation 
of  the  operating  expense  account,  appear  to  be 
inadequate,  the  Commission  has  now  specifically 
been  given  the  duty,  as  well  as  the  power  and 
jurisdiction,  to  control  the  estimated  charges  for 
"  depreciation "  and  the  basis  thereof.  The  im- 
portance of  this  we  shall  hereinafter  discuss  with 
concrete  references  to  the  so-called  "depreciation 
reserves"  of  the  carriers.  Without  the  possession 
and  exercise  of  this  power  by  the  Commission, 
any  carrier  would  be  left  in  position  to  include  in 


8 


its  operating  expenses  unnecessary  and  excessive 
charges  under  this  head  and  thus  make  its  reve- 
nues and  rates  appear  inadequate  upon  the  face 
thereof  when  in  fact  they  were  ample  or  more 
than  ample.  Another  consideration  impelling  the 
Congress  to  confer  and  the  Commission  to  exer- 
cise this  power  of  regulation  of  charges  based  on 
estimates  is  no  doubt  to  be  found  in  paragraph  6 
of  Section  15  a  of  the  same  statute,  which  requires 
that 

"If  under  the  provisions  of  this  section, 
any  carrier  receives  for  any  year  a  net  rail- 
way operating  income  in  excess  of  6  per 
centum  of  the  value  of  the  railway  prop- 
erty held  for  and  used  by  it  in  the  service 
of  transportation,  one-half  of  such  excess 
shall  be  placed  in  a  reserve  fund  established 
and  maintained  by  such  carrier,  and  the  re- 
maining one-half  thereof  shall,  within  the 
first  four  months  following  the  close  of  the 
period  for  which  such  computation  is  made, 
be  recoverable  by  and  paid  to  the  Commis- 
sion for  the  purpose  of  establishing  and 
maintaining  a  general  railroad  contingent 
fund  #  #  #" 
and  to  the  further  effect  shown  in  the  statute.    If 
the  carrier  had  been  or  were  left  subject  to  no  con- 
trol in  respect  of  the  charges  which  it  might  make 
to  operating  expenses  for  "depreciation"  it  might 
easily,  if  such  charges  were  based  on  estimates 
and  were  not  kept  in  close  relationship  to  the  ac- 
tual disbursements,  make  these  estimated  charges 
sufficiently  high  to  create  the  appearance  that  its 
"net  railway  operating  income"  for  any  year  did 
not  reach  "six  per  centum  of  the  value  of  the  rail- 
way property  held  for  and  used  by  it  in  the  service 
of  transportation' '  and  thus  deprive  the  "general 
railroad  contingent  fund"  of  moneys  that  should 
go  into  it  in  accordance  with  the  provisions  and  in- 
tent of  the  statute. 


9 


Nature  of  "Depreciation  Charges"  as  to  Railway 
Property 

In  order  to  determine  what  amounts  may  prop- 
erly be  charged  to  operating  expenses  to  repre- 
sent " depreciation' '  as  defined  in  the  Act,  and  the 
manner  in  which,  as  a  practical  business  matter, 
this  phase  of  railway  operation  and  management 
should  be  handled,  it  is  necessary  to  bear  in  mind 
the  proper  purpose  of  such  charges.  The  word 
"depreciation,"  as  commonly  used,  has  a  variety 
of  meanings.  One  of  the  most  prevalent  is  to  de- 
note a  decline  or  shrinkage  in  exchange  value  or 
market  price.  That,  however,  is  obviously  not  the 
meaning  intended  by  Congress  to  be  attached  to 
the  word  as  it  is  used  in  the  Interstate  Commerce 
Act.  Changes  in  value  are  matters  of  fact  to  be 
determined  by  observation  and  not  by  rule  pre- 
scribed by  the  Commission.  The  accounts  of  a 
carrier  must  deal  with  receipts  and  outlays — 
facts,  not  opinions  as  to  variations  in  value  or  as 
to  the  probable  lapse  of  time  before  particular 
units  of  property  will  be  retired  from  use.  The 
railway  property  of  a  carrier  is  held  for  use  and 
not  for  sale ;  and  fluctuations  in  its  value,  if  and 
as  they  occur,  do  not  have  any  relation  to  the  car- 
rier's operating  expenses.  A  merchant  may  prop- 
erly reserve  out  of  his  revenues  sums  to  provide 
against  shrinkage  in  the  value  of  goods  remain- 
ing unsold,  below  their  cost,  for,  until  the  complete 
stock  of  goods  is  sold  and  converted  into  money, 
the  real  profit  or  loss  from  his  venture  cannot  be 
ascertained.  The  rolling  stock,  road-bed  and 
equipment  of  a  carrier  by  railway  are  not  acquired 
for  sale  like  merchandise ;  they  are  expected  to  be 
operated  forever  in  furnishing  transportation,  or 
at  least  for  an  indefinitely  long  period.  The  car- 
rier soils  transportation  service  to  its  patrons,  not 


10 


its  railway  property  piecemeal.  A  railway  system 
is  composed  almost  entirely  of  tangible  property 
that  could  not  readily,  and  to  a  large  extent  could 
not  economically,  be  converted  to  other  uses.  Its 
ownership  may  change  and  the  price  at  which  the 
transfer  is  effected  may  be  greater  or  less  than 
the  cost  of  the  property  when  installed,  but  it  does 
not  appear  that  the  utility  of  the  property  or  its 
relations  to  the  shippers  and  passengers  using  it 
is  thereby  affected.  The  rate  charged  for  the 
transportation  service  does  not  depend  upon  the 
age  of  the  engine,  road-bed,  or  car;  nor  can  it 
properly  be  said  that  the  carrier's  operating  ex- 
penses vary  with  changes  in  the  exchange  value 
of  the  property  or  the  cost  of  reproducing  it  at  a 
particular  time.  As  has  been  said  by  Mr.  George 
N.  Webster  in  a  recent  monograph*  on  the  sub- 
ject: 

"The  consideration  of  age  enters  no  more 
into  the  question  of  the  rates  of  a  public 
service  company,  which  is  able  to  and  does 
render  the  service  it  was  organized  to  ren- 
der, than  does  the  age  of  a  taxicab,  or  of  its 
driver,  or  of  the  clothes  he  wears,  enter  into 
the  question  of  the  fare.  A  driver  twenty 
5rears  old  with  a  new  car  and  a  new  uniform 
can  charge  no  more  than  a  man  of  sixty 
with  a  ten-year-old  car  still  operating  effi- 
ciently. It  is  transportation  the  passenger 
is  buying — and  he  expects  to  pay  uniform- 
ly for  a  uniform  service,  regardless  of  the 
age  of  the  equipment. 

"Nor  does  a  lawyer  or  a  physician  ex- 
pect to  regulate  his  fee  by  the  age  of  his 
office  furniture,  as  one  might  think  he 
should  from  the  arguments  of  the  profes- 


♦Copies  of  Mr.  Webster's  monograph  entitled  "Theoreti- 
cal ^Depreciation:  A  Menace  to  the  Public  and  the  Inves- 
tor," have  been  reprinted,  and  will  be  furnished  to  anyone 
interested,  on  request  to  the  undersigned. 


11 


sional  depredator.  A  laborer  of  twenty 
with  a  new  pair  of  overalls  draws  the  same 
rate  per  diem  as  the  laborer  of  sixty  with  a 
pair  of  wornout  overalls.  Both  do  a  uni- 
form day's  work  for  a  uniform  day's  pay 
and  age  cuts  no  figure  so  long  as  uniformity 
in  service  capacity  exists. 

"A  celebrated  lawyer  who  died  within  a 
year  and  who  bequeathed  many  millions  of 
dollars  to  a  great  college  had  in  his  office 
the  simplest  and  oldest  furniture  the  writer 
ever  saw.    Furthermore,  his  earning  capac- 
ity increased  annually  to  the  day  of  his 
death  at  the  age  of  seventy-four.    He  prob- 
ably never  realized  what  a  liar  he  was  mak- 
ing out  of  the  professional  depredation- 
ist." 
So  far  as  the  passenger  and  the  shipper,  the 
purchasers    of    railway  service,  are   concerned, 
the  essential  thing  is  that  the  system  be  main- 
tained in  efficient  operating  condition  and  that 
its   service  be   rendered   efficiently,   economical- 
ly, and  at  a  fair  price.    Its  operating  expenses 
are  the  out-goes  necessary  to  efficient  and  eco- 
nomical operation.     It  has  been  commonly  rec- 
ognized that  in  the  case  of  a  railway  or  other 
public  utility,  the  cost  of  the  maintenance  of  the 
property  in   efficient   and   economical  operating 
condition,  through  adequate  repairs  of  wearing 
parts  and  through  the  renewal  and  replacement 
of  units  retired  from  use  for  any  cause,  is  a  proper 
charge  against  the  cost  of  rendering  the  service 
as  represented  by  operating  expenses;  and  the 
statute  has  declared  that  the  fair  price  for  the 
service  rendered  shall  be  so  determined,  as  nearly 
as  may  be,  as  to  yield,  in  addition  to  such  neces- 
sary out-goes,  a  further  sum  which  shall  be,  for  the 
carriers  as  a  whole,  in  a  given  rate  district,  "a 
fair  return  upon  the  aggregate  value  of  the  rail- 
way property  of  such  carriers  held  for  and  used 


12 


in  the  service  of  transportation."  The  statute 
does  not  contemplate  the  inclusion  of  anything 
beyond  this  in  fixing  the  rate. 

It  is  a  matter  of  common  knowledge  that  in  any 
extensive  or  complicated  system,  plant  or  instru- 
mentality, such  as  that  of  a  railway  or  public 
utility,  the  thing  does  not  wear  out  or  give  way  as 
a  whole.  Some  part  wears  or  weakens  to  the 
point  that  it  ceases  to  operate  satisfactorily,  and 
upon  being  repaired  or  replaced,  the  whole  con- 
tinues to  operate  satisfactorily.  These  repairs 
and  replacements  in  respect  of  any  particular  unit 
of  plant  or  equipment  become  necessary  only  at 
irregular  intervals,  but  in  an  extensive  and  hetero- 
geneous railway  or  utility  system  subjected  to  a 
variety  of  hazards,  they  tend  to  equalize  them- 
selves from  year  to  year,  and  the  tendency  is  still 
more  marked  if  longer  periods  be  compared. 

The  statute  does  not  indicate  how  frequently 
the  Commission  shall  revise  and  adjust  the  gen- 
eral level  of  rates  for  the  carriers  of  a  particular 
rate  district,  but  presumably  such  readjustments 
will  be  made  only  at  intervals  of  several  years. 
It  takes  an  appreciable  period  of  time  for  traffic 
to  adjust  itself  to  a  new  level  of  rates  and  such 
level  ought  not  to  be  disturbed  until  it  becomes 
clear  that  it  is  inadequate  or  excessive.  If  the 
intervals  between  readjustments  of  rate  levels 
are  long  enough  to  permit  the  law  of  averages  to 
operate  with  respect  to  repairs  and  renewals  and 
replacements  of  rolling  stock  and  equipment,  it 
seems  apparent  that  there  would  be  no  occasion 
at  all  for  the  introduction  of  any  estimated 
charges  into  operating  expenses,  to  secure  a  fair 
statement  of  cost  of  operation  for  the  period.  If 
the  intervals  are  too  short  for  this,  the  justifica- 
tion arises  for  the  admission  of  charges  based  on 


13 


estimates  of  current  outlays.  Such  estimates, 
however,  when  permissible,  should  be  restricted 
to  elements  other  than  anticipated  shrinkage  in 
" value' '  of  parts  of  the  property,  for*  as  has 
been  said  above,  the  carrier  is  not  a  trader  or 
merchandiser  in  respect  of  its  railway  property 
and  its  duty  in  connection  with  its  property  is  to 
maintain  the  same  in  efficient  operating  condition 
and  to  operate  it  efficiently  and  economically  in 
the  transportation  of  goods  and  persons ;  and  any 
charges  for  repairs,  renewals  and  replacements, 
whether  actual  or  estimated,  should  be  based  only 
upon  the  actual  requirements  for  those  purposes. 

When  any  part  of  a  unit  of  railway  property 
wears  to  such  a  point  that  the  particular  unit 
no  longer  operates  efficiently,  it  is  the  carrier's 
duty,  under  the  statute  and  in  the  exercise  of  ordi- 
nary business  judgment  alike,  to  either  repair  it 
or  replace  the  wearing  part  of  such  unit,  and 
thereby  to  overcome  the  actual  deterioration  of 
the  unit  and  restore  it  to  full  operating  efficiency. 
If  in  the  interval  since  a  complete  unit  was  in- 
stalled, the  art  of  transportation  has  progressed 
to  such  a  point  that  it  has  become  obsolete  or  is 
inadequate  and  the  economies  to  be  realized 
justify  its  withdrawal  from  service,  it  should  be 
replaced  with  a  unit  of  improved  type  and  ade- 
quate capacity,  and  the  cost  of  retiring  the  obso- 
lete or  inadequate  unit,  if  too  great  to  charge 
against  the  provision  for  renewals  for  the  cur- 
rent year,  should  be  borne  by  future  passengers 
and  shippers.  "Abandonments  occasioned  by 
changes  of  this  character  are  therefore  charge- 
able to  future  earnings."  (Kansas  City  Southern 
Ry.  Co.  vs.  U.  S.,  231  U.  S.,  423,  451,  452.) 


14 
The  Sound  Treatment  of  "Retirement  Expense" 

When  a  given  unit  of  property  used  in  transpor- 
tation service  is  installed,  the  executives  who 
financed  its  installation  and  are  charged  with  the 
duty  of  maintaining  the  property  as  a  whole  and 
with  making  financial  provision  therefor,  realize 
that  certain  things  may  transpire  as  to  the  new 
unit  of  property  or  portions  thereof.  If  it  is  of 
such  a  character  that  it  has  wearing  parts,  or  that 
portions  of  it  will  be  affected  by  the  action  of  the 
elements,  the  executives  of  course  are  aware  that 
repairs  of  such  wearing  parts  will  have  to  be  made 
from  time  to  time,  else  the  unit  and  property  as 
a  whole  will  not  function  efficiently  and  will  break 
down  altogether  if  these  repairs  are  not  made  as 
required.  On  the  other  hand,  they  are  aware  that 
a  large  portion  of  the  property,  at  least  if  properly 
maintained  by  these  repairs  and  renewals  of  wear- 
ing parts,  has  a  practically  indefinite  life  in  ser- 
vice, unless  its  retirement  from  use  comes  about 
from  causes  in  no  way  related  to  the  effects  of 
use.  At  a  recent  hearing  before  the  Federal 
Power  Commission,  the  Secretary  of  War,  Mr. 
Weeks,  trenchantly  inquired  of  a  distinguished 
hydraulic  engineer  whether  an  estimate  could 
soundly  be  made  as  to  the  probable  "life"  of  a 
dam  such  as  would  figure  in  a  water-power  pro- 
ject. The  reply  was,  in  substance,  that  such  a 
thing  could  hardly  be  calculated,  because  dams 
known  to  be  more  than  2,000  years  old  are  still 
functioning  and  in  use,  with  no  signs  of  going 
out  of  service  because  of  any  consequences  of  age, 
use  ,or  wear.  Probably  these  dams,  too,  have  had 
practically  no  repair  work  done  upon  them  since 
they  were  built  before  the  Christian  era. 

As  has  been  said  by  Mr.  Webster  in  the  mono- 
graph already  referred  to : 


15 


"Stephenson's  second  locomotive  was 
still  in  use  in  1911  (Engineering  and  Con- 
tracting, October  11,  1911).  The  cast-iron 
water-pipes  leading  from  the  river  Seine 
to  the  fountains  at  Versailles,  were  install- 
ed in  1658.  The  only  repairs  that  have  been 
necessary  after  two  and  a  half  centuries  of 
service  is  the  occasional  replacing  of  bolts 
(Engineering  and  Contracting,  May  27, 
1914).  Rome  is  still  supplied  with  water 
by  an  aqueduct,  the  construction  of  which 
was  begun  by  Quintus  Marcius  in  144  B. 
C.  Tunis  is  now  supplied  by  an  aqueduct 
built  by  Hadrian  in  A.  D.  120.  The  aque- 
duct at  Nimes  has  been  in  use  for  nearly 
twenty  centuries.  There  are  many  other 
instances  of  masonry  and  concrete  struct- 
ures which  have  survived  many  hundreds 
of  years  of  useful  service." 

The  wearing  parts  of  units  of  railway  property 
are  currently  repaired  as  needed,  and  the  effect 
is  to  maintain  the  unit  in  existence  and  in  high 
operating  efficiency,  for  an  indefinite  and  unde- 
finable  period,  and  the  expense  of  this  repair  and 
replacement  of  wearing  parts  is  properly  assessed 
by  the  company  executives  against  the  current  cost 
of  rendering  the  service  in  which  the  use  and  wear 
took  place. 

The  responsible  executives  of  the  carrier  also 
realize  that  although  the  newly  installed  unit  may 
continue  in  use  for  an  indefinite  and  incalculable 
period,  if  thus  maintained  in  good  operating  con- 
dition, it  may  go  out  of  use,  for  other  causes  than 
wear  or  the  flight  of  time,  and  that  such  retire- 
ment from  use  may  come  about  at  almost  any  time 
— a  time  in  no  way  susceptible  of  estimate  at  the 
time  it  is  installed,  but  varying  altogether  with 
the  particular  carrier,  the  particular  territory  be- 
ing served,  the  nature  of  the  service  being  ren- 
dered, the  various  factors  affecting  the  cost  of  ser- 


16 


vice,  and  the  like.  The  unit  may  be  retired  from 
use  because  it  has  become  inadequate  to  meet  the 
growing  demands  for  service  (and  hence  is  uneco- 
nomical) or  because  new  inventions  have  resulted 
in  improvements  in  the  type  of  a  given  unit,  mak- 
ing its  retirement  economical  in  the  interests  of 
future  patrons.  A  larger  volume  of  traffic  can  be 
handled  or  the  existing  volume  of  traffic  can  be 
handled  more  cheaply  or  more  efficiently,  if  the 
present  unit  is  removed  and  a  new  one  put  in,  al- 
though the  unit  taken  out  is  still  functioning  as 
efficiently  as  when  installed.  The  time  when  such 
supersession  of  a  unit  will  take  place  cannot  be 
forecast  in  terms  of  years,  by  company  executives, 
engineers,  or  any  one  else,  at  the  time  the  unit 
is  installed.  "Tables  of  useful  lives"  of  units  of 
that  kind  are  unavoidablly  conjectural  and  spec- 
ulative, bearing  no  possible  relationship  to  the 
controlling  factors,  which  vary  utterly  with  the 
individual  instance.  To  try  to  "assign"  a  prob- 
able period  of  "life"  to  the  unit  when  it  is 
installed,  and  then  charge  against  current  rates 
an  accrual  based  on  the  amortization  of  the  cost 
of  the  unit  over  that  period,  is  to  set  up  a  sys- 
tem of  swelling  operating  expenses  and  "pad- 
ding" rates  on  a  basis  of  mere  conjectures,  be- 
cause with  the  great  mass  of  railway  property 
its  proper  maintenance  by  current  repairs  con- 
signs all  "life  tables"  to  the  realm  of  silly  im- 
practicabilities, and  supersession,  when  it  does 
take  place,  occurs  for  causes  in  no  way  related 
to  such  "life  tables."  Moreover,  such  superses- 
sion comes  about  for  causes  which  make  im- 
proper the  amortization  of  its  cost  through  in- 
creased rates  during  the  period  before  it  is  super- 
seded. The  unit  did  not  wear  out  in  the  service 
of  the  patrons  it  served.  They  paid  the  cost  of 
maintaining  it  in  good,  undiminished  operating 


17 


efficiency;  there  is  no  reason  why  they  should,  in 
addition,  pay  the  cost  of  retiring  it  to  put  in  a 
new  unit  which  will  serve  more  patrons  or  serve 
future  patrons  more  cheaply.  The  existing  unit 
was  serving  present  patrons  efficiently;  the  cost 
of  retiring  it  to  put  in  a  larger  or  more  economi- 
cal unit  becomes  a  proper  charge  against  those 
who  will  be  served  and  benefited  thereby.  The  ex- 
pense of  retiring  property  should  therefore  be 
borne  by  current  or  future  charges,  and  not  by 
anticipatory  accruals  (Kansas  City  Southern  Ry. 
Co.  vs.  U.  8.,  231 U.  8.,  423, 451-2) ;  in  other  words, 
the  retiring  of  a  very  large  unit  may  necessitate 
the  distribution  of  the  amortization  of  the  invest- 
ment therein,  over  a  short  period  of  succeeding 
years. 

It  thus  appears  that  wherever  departure  is 
made  from  the  actual  current  outlays,  year  by 
year,  for  repairs  and  for  the  renewal  and  re- 
placement of  property  withdrawn  from  service, 
"  depreciation ' '  charges  in  operating  expenses 
should  in  any  event  be  restricted  to  those  neces- 
sary to  equalize  from  year  to  year  the  charges  for 
extraordinary  repairs  and  for  renewals  and  re- 
placements which  occur  irregularly.  As  experi- 
ence shows  that  in  large  plants  and  other  utilities 
whose  property  is  distributed  sufficiently  widely 
to  be  subjected  to  a  variety  of  hazards,  the  actual 
costs  of  repairs  and  retirements  tend  to  equalize 
themselves  when  taken  over  a  period  of  years,  it 
is  apparent  that  there  is  no  need  at  all  for  per- 
mitting the  introduction  of  estimated  charges  in 
operating  expenses  to  cover  the  matter  of  "depre- 
ciation" in  connection  with  the  determination  of  a 
fair  level  of  rates  as  defined  in  the  statute,  unless 
the  Commission  contemplates  frequent  readjust- 
ments of  the  rate  level.  If  such  frequent  read- 
justments are  contemplated,  the  regulation  of  such 


18 


charges  should  be  based  on  the  actual  present 
and  past  experience  of  the  carriers,  and  the 
charges  themselves  should  be  proportioned  on  the 
basis  of  the  work  done  rather  than  on  mere  lapse 
of  time  Extensive  reconstruction  projects  involv- 
ing numerous  renewals  and  replacements  cannot 
advisably  be  undertaken  at  a  time  of  the  year 
when  the  plant  is  working  under  full  load  or  over- 
load, for  at  such  times  operation  would  be  too 
much  impeded  by  the  execution  of  any  mainte- 
nance work  in  excess  of  actual  immediate  needs. 
Furthermore,  at  such  times  prices  are  usually 
high  and  the  supply  of  materials  and  labor  re- 
stricted, and  it  would  be  uneconomical  to  do  work 
of  this  character  which  is  not  absolutely  essential 
to  the  continuity  of  operation.  In  such  periods, 
therefore,  when  the  actual  disbursement  for  main- 
tenance work  is  comparatively  small,  the  esti- 
mated charges  may  properly,  if  ever,  be  intro- 
duced in  operating  expenses  to  make  provision  for 
the  time  when  traffic  has  slackened  and  the  forces 
of  the  carrier  can  advantageously  be  concentrated 
on  maintenance  work. 

Analysis  of  the  "Depreciation  Charges"  of  Railway 
Carriers  Since  1912 

Illustration  of  the  pertinency  of  the  foregoing 
suggestion  that  care  be  taken  to  limit  "deprecia- 
tion charges' '  to  actual  maintenance  requirements 
rather  than  to  base  them  on  tables  of  assumed 
"lives' ■  of  property,  is  afforded  by  the  fact  that 
an  examination  of  the  figures  published  in  the  In- 
terstate Commerce  Commission's  reports  on  rail- 
way statistics  shows  that  during  the  four  years 
from  June  30,  1912  to  June  30,  1916,  the  credit 
balance  in  the  reserve  account  "Accrued  depre- 
ciation" for  all  Class  I  railways  and  their  non- 
operating  subsidiaries  increased  from  about  $300,- 


19 


000,000.00  to  about  $555,000,000.00.  In  other 
words,  the  charges  to  operating  expenses  for  "  de- 
preciation' '  during  those  four  years  were  $255,- 
000,000.00  greater  than  was  necessary  to  provide 
for  all  retirements  of  equipment  and  other  rail- 
way property  made  during  that  period  and 
charged  against  the  reserve  thus  created.  How- 
ever, owing  to  some  anomalies  in  the  Commis- 
sion's rules  of  accounting  at  that  time  in  force, 
there  were  charges  made  to  "Profit  and  Loss" 
account  to  the  extent  of  about  $59,000,000.00  for 
"loss  On  retired  road  and  equipment.' '  Granting, 
for  the  sake  of  argument,  that  all  of  this  $59,- 
000,000.00  might  properly,  in  the  absence  of  the 
"depreciation"  charges  in  operating  expenses, 
have  been  made  to  operating  expenses*  it  is  still 
true  that  the  charges  to  operating  expenses  in  this 
connection  were  about  $196,000,000.00  (the  differ- 
ence between  $255,000,000.00  and  $59,000,000.00) 
greater  than  were  necessary  to  provide  for  all  re- 
tirements actually  made  during  those  four  years, 
or,  in  other  words,  for  all  renewals  and  replace- 
ments necessitated  during  that  period  on  the  as- 
sumption that  such  renewals  and  replacements 
had  cost  no  more  than  did  the  things  renewed  or 
replaced.  The  Commission's  rules  properly  per- 
mit the  excess  cost  of  the  replacement  over  the 
cost  of  the  original  to  be  charged  to  the  road  and 
equipment  account,  so  that  it  is  shown  by  the 
Commission's  figures  that  the  operating  expenses 
of  Class  I  carriers  and  their  subsidiaries  were 
overstated  during  those  four  years  by  nearly 
$200,000,000.00.  Similarly,  for  the  eighteen 
months  from  June  30, 1916,  to  December  31, 1917, 
the  credit  balance  in  the  reserve  account  "Ac- 
crued Depreciation"  for  such  carriers  increased 
about  $224,000,000.00,  whereas  the  charges  to 
"Profit  and  Loss"  for  "loss  on  retired  road  and 


20 


equipment,"  during  the  twenty-four  months  from 
December  31,  1915,  to  December  31,  1917,  were 
about  $30,000,000.00.  Owing  to  the  change  in  the 
reporting  year  from  that  ending  June  30th  to  that 
ending  December  31st,  there  is  an  overlap  of  six 
months  in  the  income  accounts  and  profit  and  loss 
accounts  contained  in  the  annual  reports  relating 
to  the  year  ended  June  30,  1916,  and  that  ended 
December  31,  1916,  and  it  is  impracticable  to  say, 
from  the  figures  published  by  the  Commission, 
what  this  item  of  "loss  on  retired  road  and  equip- 
ment' '  charged  to  "Profit  and  Loss'  is  for  the 
eighteen  months  from  June  30,  1916,  to  Decem- 
ber 31,  1917.  It  is  safe  to  say,  however,  that  it 
is  materially  less  than  thirty  millions  of  dollars, 
and  therefore  that  the  amounts  charged  to  operat- 
ing expenses  for  "depreciation"  during  those 
eighteen  months  were  more  than  $194,000,000.00 
in  excess  of  the  amount  of  retirements  actually 
made  during  that  period,  so  that  for  the  five  and 
one-half  years  from  June  30,  1912,  to  December 
31, 1917,  the  amounts  charged  for  "depreciation" 
in  operating  expenses  were  over  $390,000,000.00 
more  than  was  necessary  to  provide  for  all  6f  the 
retirements  actually  made  during  the  period;  or, 
in  other  words,  the  operating  expenses  of  this 
class  of  railroad  common  carriers  as  reported 
during  that  period  were,  so  far  as  this  item  is 
concerned,  overstated  by  at  least  $390,000,000.00, 
with  corresponding  effect  upon  the  net  operat- 
ing income  and  so  upon  the  apparent  adequacy  or 
inadequacy  of  the  rates  paid  by  the  companies 
represented  by  the  undersigned,  in  common  with 
all  other  users  of  similar  commodities,  for  the 
transportation  of  coal,  oil,  iron,  steel,  pipe  and 
other  materials  in  inter-state  commerce. 

Another  concrete  instance  emphasizing  the  im- 
portance of  sound  treatment  of  "retirement  ex- 


21 


pense"  may  be  taken  from  the  records  of  a  reg- 
ulated utility  of  whose  service  the  Consolidated 
Gas  Company  (with  its  affiliated  companies)  is 
probably  the  largest  single  patron.  The  sums 
which  we  have  to  pay  for  telephone  service  enter 
heavily  into  our  operating  expenses,  amounting  to 
more  than  $200,000  per  year.  Examination  of  the 
figures  published  by  the  Public  Service  Commis- 
sion for  the  Second  District  shows  that  as  of  De- 
cember 31, 1914,  the  credit  balance  in  the  two  re- 
serve accounts  of  the  New  York  Telephone  Com- 
pany, entitled  "Accrued  Depreciation"  and 
"Amortization,"  was  $25,498,912.  Five  years 
later,  after  taking  care  of  all  retirements  of  fixed 
capital  actually  made  over  this  considerable  per- 
iod, the  accruals  had  increased  the  reserves  to 
$63,390,038.  In  other  words,  the  rates  charged' 
during  the  five  years  had  included  the  collection 
by  the  company,  from  us  and  other  consumers, 
of  $37,891,126  more  than  the  actual  cost  of  prop- 
erty retirements  during  the  same  period.  In  the 
same  five  years,  the  telephone  company's  invest- 
ment in  fixed  capital  devoted  to  its  telephone  busi- 
ness was  increased  $76,805,076  by  the  addition  of 
new  facilities  and  equipment.  Thus  while  less 
than  $77,000,000  of  new  property  was  being  in- 
stalled, 49.33  per  cent,  of  its  total  cost  was  being 
collected  from  consumers,  over  and  above  the  ac- 
tual requirements  for  the  five  years,  on  the  theory 
of  providing  for  possible  but  uncertain  future  re- 
tirements. During  the  eight  months  ended  August 
31,  1920,  the  credit  balance  in  these  reserves  was 
increased  $6,580,064  over  actual  retirement  ex- 
penses, whereas  only  $14,460,695  was  in  the  same 
period  added  to  the  company's  capital  investment. 
In  other  words,  over  a  period  covering  five  years 
and  eight  months,  the  company  collected  from 
its  consumers,  to  make  good  its  losses  from  the 


22 

retirement  of  property  from  service,  $44,471,190 
more  than  its  actual  losses  from  such  retirements 
over  this  considerable  period,  or  approximately 
$7,850,000  in  excess  of  average  actual  yearly  re- 
quirements ;  and  the  credit  balance  in  its  reserves, 
as  of  August  31,  1920,  representing  collections 
from  consumers  over  actual  retirements,  was  $69,- 
970,102,  or  nearly  35  per  cent,  of  its  aggregate 
property  investment  of  $240,432,094. 

Whether  the  rates  charged  by  the  telephone 
company  or  by  the  railway  carriers  are  or  were 
reasonable  or  excessive,  we  do  not  undertake  to 
say.  That  question  is  for  the  regulatory  commis- 
sions charged  with  the  duty  of  seeing  to  it  that 
such  rates  are  kept  neither  too  high  nor  too  low. 
Our  comments  are  only  upon  a  system  of  accruals 
through  charges  to  operating  expenses  on  the  basis 
of  theoretical  estimates,  which  lead  to  the  col- 
lection of  sums  so  greatly  in  excess  of  the  actual 
retirement  expense  over  a  representative  period. 
Whether  the  rates  actually  charged  yielded 
more  than  a  fair  return  over  and  above  actual 
operating  expenses,  we  do  not  here  discuss.  Any 
sums  collected  in  excess  of  actual  operating  costs, 
including  the  actual  retirement  expenses  (aver- 
aged, if  desired,  over  a  representative  period) 
should  be  collected  as  return  on  investment  or  not 
at  all.  No  carrier  or  utility  should  be  permitted 
to  collect  from  its  patrons  more  than  its  operating 
expenses  plus  a  fair  return,  and  no  carrier  or  util- 
ity should  be  permitted  to  make  its  return  from 
existing  rates  appear  inadequate  through  charg- 
ing to  operating  expenses  a  sum  whose  accrual  is 
not  required  by  any  actual  outlays  of  the  com- 
pany, either  current  or  prospective.  No  implica- 
tion is  intended  to  be  conveyed,  against  the  policy 
of  making  reserves,  out  of  the  fair  return,  for 
contingencies,  if  it  is  deemed  advisable  to  thus 


23 


segregate  a  part  of  the  surplus  earnings.  There 
should  be  left,  however,  nr  room  for  doubt  that 
when  thus  segregated  such  a  reserve  still  repre- 
sents surplus  earnings  belonging  to  the  stockhold- 
ers and  that  upon  the  property  in  which  it  is  in- 
vested the  company  has  as  unquestionable  a  right 
to  earn  a  fair  return  as  it  has  upon  the  property 
representing  its  surplus  so  called. 

Concrete  Recommendations  as  to  the  Handling  of 
Depreciation  Charges 

These  were  the  practical  considerations  which 
led  the  Consolidated  Gas  Company  of  New  York, 
in  its  petition  of  June  1, 1920,  as  intervenor  in  Ex 
Parte  74  before  the  Commission,  relative  to  in- 
creases in  freight  rates,  to  present  to  the  Commis- 
sion a  more  formal  statement  of  the  foregoing  con- 
tentions, and  accordingly  to  urge  upon  the  Com- 
mission the  following  suggestions,  which  are  of 
equal  pertinency  to  your  present  inquiry: 

"1.  That  the  above-stated  considera- 
tions be  taken  into  account  and  kept  in  mind 
by  the  Commission  in  all  pending  and  fu- 
ture proceedings  for  the  fixation  of  the 
rates  chargeable  by  railroad  common  car- 
riers in  inter-state  commerce. 

"2.  That  the  petitioner  be  permitted  to 
intervene  and  be  heard,  by  counsel,  in  such 
proceedings,  and  to  file  a  brief  therein,  in 
behalf  of  the  considerations  hereinbefore 
stated. 

"3.  That  the  Commission  will  find  that 
for  Class  I  carriers  there  are  no  *  classes 
of  property  for  which  depreciation  charges 
may  properly  be  included  under  operating 
expenses,'  and  that  it  will  require  that  the 
maintenance  charges  for  any  calendar  year, 
including  charges  for  renewals  and  replace- 
ments, be  stated  on  the  basis  of  expenses 
actually  incurred  during  that  year,  to  the 


24 

end  that  freight  rates  be  placed  at  a  level 
which  will  be  fair  both  to  carriers  and  to 
shippers,  and  that  they  be  not  made  unduly 
high  in  order  to  provide  for  estimated 
charges  not  based  on  actual  facts. 

"4.  In  the  event  that  the  Commission  be 
of  opinion  that  a  year  is  not  a  sufficiently 
long  period  to  include  representative  fluctu- 
ations in  maintenance  charges,  the  petition- 
er prays  that  the  rules  governing  estimated 
charges  for  'depreciation'  shall  hereafter 
be  based  on  the  actual  experience  of  the 
carriers  during  a  period  of  a  length  reason- 
ably sufficient  to  include  such  fluctuations 
and  that  the  estimated  charge  shall  be  dis- 
tributed from  year  to  year  upon  a  suitable 
operating  unit  (such  as,  for  example,  car- 
miles),  so  that  during  years  of  heavy  traffic 
the  estimated  charge  may  be  correspond- 
ingly great  and  during  years  of  light  traf- 
fic it  may  be  correspondingly  less,  and  thus 
avoid,  so  far  as  may  be,  fictitious  fluctua- 
tions in  the  'net  railway  operating  income' 
which  the  statute  makes  the  test  of  the  ade- 
quacy or  inadequacy  of  a  given  schedule  or 
level  of  rates." 

The  Two  Opposing  Views  as  to  Provisions  for  the 
Upkeep  of  Property 

In  line  with  the  foregoing,  there  may  be  said  to 
be  two  opposite  views,  two  radically  differing  pol- 
icies, which  may  be  followed  by  a  regulatory  body 
in  fulfilling  duties  such  as  those  devolved  upon  the 
Interstate  Commerce  Commision  by  Section  20 
of  the  Interstate  Commerce  Act  as  amended: 

1.  The  course  four-square  with  business 
practice  in  large  utility  and  industrial  es- 
tablishments; which  recognizes  that  prop- 
erty used  in  public  service  does  not  go  out 
of  use  on  arbitrary  or  theoretical  grounds 
or  according  to  any  preconceived  "table  of 
lives,"  but  for  reasons  not  calculable  in  ad- 
vance as  to  time,  and  commonly  related  to 


25 


economies  in  the  cost  of  service  or  increases 
in  demand  for  service ;  and  hence  does  not 
make  "accruals"  of  reserves  over  estimat- 
ed periods  to  provide  for  a  "going  out  of 
use"  which  does  not  occur  with  any  calcu- 
lable reference  to  such  estimates  or  such 
periods  and  does  not  undertake  to  burden 
present  consumers  or  patrons  with  the  cost 
of  retiring  property  altogether  adequate 
for  their  needs  but  not  adequate  for  the 
needs  of  a  larger  number  of  patrons  or  not 
as  economical  in  serving  future  patrons  as 
some  newly  developed  unit  or  machine. 

2.  The  course  predicated  on  preconceiv- 
ed "lives  of  property";  which  disregards 
actualities  and  substitutes  for  business  ex- 
perience the  theories  of  academicians; 
which  creates  unnecessary  charges  to  cur- 
rent operating  expenses  to  create  unneces- 
sary "reserves,"  all  to  the  end  that  through 
these  accruals  current  passengers  and 
shippers  may  be  compelled  to  contribute  to 
a  piece-meal  but  surreptitious  "purchase" 
of  the  property,  to  be  effected  by  the  deduc- 
tion of  the  amount  of  such  reserves  from 
the  sum  on  which  the  company  would  other- 
wise be  entitled  to  earn  a  return  or  the  sum 
for  which  the  company  would  be  entitled 
to  be  compensated,  when,  if  ever,  the  "the- 
oretical depredationists"  have  their  way 
and  the  Federal  Government  takes  over 
railroad  property  for  governmental  owner- 
ship and  operation. 

Decisions  of  the  Courts  and  Regulatory  Commissions 
Concerning  These  Opposing  Views 

Although  we  recognize  that  a  business  problem 
of  this  character  cannot  be  solved  merely  by  cita- 
tion of  judicial  decisions,  we  believe  that  an  analy- 
sis of  the  pertinent  rulings  may  prove  of  assist- 
ance to  the  Depreciation  Section  and  the  Bureau 
of  Accounts  at  this  juncture.    Particularly  in  the 


26 


early  years  of  rate  litigation,  it  cannot  be  said 
that  the  courts  always  perceived  the  problem  in 
all  its  aspects  or  phrased  their  discussion  of  it 
with  the  exactness  of  expression  which  has  come 
with  fuller  consideration.  It  remains  true  that  no 
leading  or  well-considered  case  has  decided  that 
"accrued  theoretical  depreciation"  must  be  de- 
ducted from  the  so-called  "rate  base"  and  pro- 
vided for  in  the  rate.  The  trend  of  decision  is 
unmistakably  toward  rejection  of  this  concept 
altogether.  As  has  recently  been  said  by  Ex- 
Judge  H.  M.  Wright,  the  distinguished  Special 
Master  who  has  heard  many  of  the  rate  cases 
arising  on  the  Pacific  Coast,  the  whole  subject 
must  be  re-examined  and  earlier  conclusions  re- 
vised, because  of  the  trend  of  judicial  decisions 
and  recent  literature.  ( See  Pacific  Gas  and  Elec- 
tric Co.  vs.  City  and  County  of  San  Francisco; 
V.  S.  Dist.  Ct;  No.  Dist.  of  Cal.;  Report  filed 
March  2,  1920,  quoted  from  on  page  71,  post). 

One  of  the  most  recent  decisions  in  the  Federal 
Courts  was  in  New  York  and  Queens  Gas  Com- 
pany vs.  Neivton,  et  al.,  in  the  United  States  Dis- 
trict Court  for  the  Southern  District  of  New  York, 
on  November  19,  1920,  before  Mayer,  D.  J.,  on  a 
motion  to  confirm  the  Report  and  Opinion  of  the 
Honorable  A.  S.  Gilbert  as  Special  Master.  (  See 
269  Fed.  277,  285,  and  supplemental  opinion  by 
Mayer,  D.  J.,  not  officially  reported).  The  Special 
Master  had  ruled  that  there  should  be  no  deduc- 
tion from  actual  investment  or  present  value  of 
property,  for  so-called  "expired  life"  or  "accrued 
theoretical  depreciation,"  and  the  District  Court 
agreed  with  him  and  refused  to  make  any  such 
deduction,  upholding  the  Master's  findings. 

The  whole  issues  of  fact  and  engineering  and 
accounting  experience  having  to  do  with  the  main- 


27 


tenance  of  property  and  the  provisions  to  be  made 
for  renewals  and  replacements  were  exhaustively 
litigated  in  this  case,*  and  the  Report  and  Opinion 
therein  seem  conclusively  to  establish  the  pro- 
priety of  handling  these  matters  in  the  practical 
business  way  urged  in  this  memorandum.  We 
quote  from  the  opinion  of  the  Special  Master  in 
the  New  York  and  Queens  Gas  Company  case,  and 
urge  that  the  matters  of  fact  therein  set  forth  are 
fatal  to  the  theoretical  assumptions  on  which 
some  of  the  proposed  regulations  on  this  subject 
are  based  (269  Fed.  277,  285) : 

"No  Deduction  for  'Accrued  Theoretical 
Depreciation' 

"In  determining  that  the  complainant's 
property  has  a  fair  present  value  of  at 
least  the  amount  of  the  complainant's  ac- 
tual investment  therein  as  found  by  me, 
viz.,  at  least  $1,655,877.94,  I  have  made  no 
deduction  for  what  is  termed  'depreciation,' 
in  whatever  way  calculated.  Under  any 
basis  of  determining  present  value,  the 
complainant's  property  is  now  worth  at 
least  the  amount  of  such  investment  there- 
in, and  the  sound  rule  of  law  and  policy 
seems  to  require  the  allowance  of  a  rea- 
sonable return  upon  at  least  that  sum. 

"Upon  the  present  trial,  it  was  insistent- 
ly urged  upon  me  by  some  of  the  defend- 
ants that  there  should  be  deducted  from 
the  cost  of  the  property  (irrespective  of 
whether  'original,'  'pre-war,'  or  'present 
reproduction'  cost  be  under  consideration) 
an  amount  claimed  to  represent  so-called 
'accrued   theoretical   depreciation,'   based 


•On  March  6,  1922,  the  Supreme  Court  of  the  United 
States,  in  a  memorandum  opinion  filed  contemporaneously 
with  the  opinion  sustaining  the  report  of  the  same  Special 
Master  in  Consolidated  Gas  Company  vs.  Newton,  el  a\ 
(see  pages  32-35,  post),  unanimously  affirmed  the  decree 
of  the  lower  Court. 


28 


upon  an  assumption  of  'life  expectancy' 
for  a  gas  plant  and  equipment  and  the  es- 
timated or  known  number  of  years  since 
the  same  was  erected  or  installed.  From 
the  testimony  given  upon  the  trial,  I  was 
strongly  impressed  by  the  fact  that  in  re- 
spect of  a  very  large  proportion  of  gas 
property,  there  is  no  ascertainable  'life  ex- 
pectancy.' The  withdrawal  of  such  prop- 
erty from  service  comes  about  from  inade- 
quacy or  obsolescence  which  cannot  be 
forecast  in  terms  of  years  or  even  satisfac- 
torily guessed  at.  Certain  parts  of  operat- 
ing machinery  and  equipment  are  of  course 
subject  to  effects  of  use.  The  replacement 
of  these  wearing  parts  enters  into  the  cost 
of  repairs.  As  to  the  substantial  units  of 
structures,  apparatus,  mains,  and  equip- 
ment, their  withdrawal  from  the  property 
accounts  comes  about  from  causes  not  at- 
tributable to  the  condition  of  the  property 
itself  or  any  diminution  in  its  operating  ef- 
ficiency, but  varying  utterly  with  the  par- 
ticular plant,  time,  local  conditions  and  ser- 
vice demands  and  hence  capable  of  being 
forecast  only  as  the  occasion  for  such 
change  in  plant  or  equipment  becomes  im- 
minent. 

"The  Renewal  and  Replacement  of  Gai 
Property 

"In  other  words,  in  order  to  keep  abreast 
of  improvements  in  the  art  of  making  and 
distributing  gas  when  and  as  it  becomes  ec- 
onomically advantageous  to  do  so,  and  to 
meet  the  growing  demand  of  the  public  for 
service  more  adequately  and  economically 
than  would  be  possible  through  merely  mak- 
ing additions  and  extensions  to  existing 
plant  and  equipment,  larger  or  better  and 
more  economical  and  efficient  units  of  plant 
and  equipment  are  from  time  to  time  in- 
stalled to  take  the  place  of  units  which  still 


29 


are  operating  as  efficiently  as  when  first  in- 
stalled. The  loss  due  to  such  supersession 
cannot  properly  be  said  to  have  accrued 
during  the  period  the  superseded  unit  was 
in  service.  It  occurred  when  supersession 
took  place.  It  became  a  proper  charge 
against  the  economies  to  be  realized  there- 
from. It  furnished  no  basis  for  the  imposi- 
tion of  an  additional  charge  against  the 
user  of  the  superseded  unit  during  the  per- 
iod of  its  useful  service  over  and  above  the 
higher  cost  of  operating  it.  Such  a  charge 
could  not  be  justified  either  on  the  ground 
that  the  unit  was  losing  potential  fife,  or 
that  the  capital  invested  in  it  was  being 
consumed,  because  neither  is  true. 

"Additional  Burden  on  the  Consumer 
Unwarranted 

"In  order  to  justify  the  deduction  of 
'theoretical  depreciation,'  I  was  asked  in 
this  case  to  assume  that  a  'depreciation  re- 
serve' equal  to  the  computed  'theoretical 
depreciation'  had  been  collected  from  the 
public,  and  then  to  deduct  from  the  com- 
pany's investment  the  amount  of  such  as- 
sumed reserve.  No  such  reserve  had,  in 
fact,  been  collected  or  accumulated  by  this 
company.  The  rate  chargeable  did  not  per- 
mit it,  and  there  is  no  reason  to  believe  that 
the  Legislature,  in  prescribing  the  rate, 
ever  contemplated  it.  As  I  have  set  forth 
in  Findings  Nos.  32  and  27  of  my  Keport 
and  as  I  have  elsewhere  indicated  herein, 
the  complainant  gas  company  has  maintain- 
ed its  property  and  investment  intact  in 
the  past,  through  renewals  and  replace- 
ments, at  an  average  actual  cost  of  approx- 
imately three  cents  per  thousand  cubic  feet 
of  gas  sold,  and  no  reason  appears  for  be- 
Jioving  that  it  cannot  continue  to  do  so  on 
that  basis.  Even  assuming  that  the  statute 
permitted  such  a  rate,  to  have  imposed  on 


30 


the  company's  consumers  an  additional 
burden  nearly  twice  as  great,  representing 
a  purely  theoretical  item  of  operating  cost, 
merely  to  accumulate  a  useless  reserve  to 
justify  a  drastic  deduction  from  invest- 
ment in  some  ultimate  proceeding  as  to 
rates,  could  not  have  been  justified  on  any 
sound  theory  in  the  past  and  cannot  now 
be  sustained  as  to  the  future. 


"Effects  of  an  Unnecessary  Reserve 

"In  order,  to  justify  the  assumption  that 
a  'depreciation  reserve'  was  or  should  have 
been  collected,  defendants'  witness  Hine 
testified  in  this  case  that  such  a  reserve 
was  necessary  'so  that  when  the  property 
is  retired  for  any  cause  whatsoever  the 
fund  can  be  charged  with  the  cost  of  the 
property.'  He  testified  also  that  the  re- 
serve should  be,  in  his  opinion,  'invested  in 
the  property,'  and  that  when  the  funds  were 
needed  for  renewals  and  replacements  they 
would  be  provided  'by  issuing  securities 
against  construction  work  which  had  been 
done  originally  out  of  this  fund,  for  the 
money  laid  aside  for  this  fund,  just  to  re- 
imburse the  treasury  on  account  of  these 
expenditures.'  This  view  seemed  to  me  to 
disregard  the  obvious  fact  that  having  de- 
ducted the  amount  of  the  reserve  tempor- 
arily invested  in  property  from  that  on 
which  he  proposed  the  company  should  be 
allowed  to  earn  a  return,  he,  to  all  intents 
and  purposes,  destroyed  the  earning  power 
of  such  property  and  investment;  that 
therefore  he  could  not  issue  any  securities 
against  such  property,  there  being  no  earn- 
ings therefrom  with  which  to  pay  interest 
on  the  securities;  that  the  reserve  could 
never  thereafter  be  availed  of  for  the  pur- 
pose for  which  it  was  alleged  to  have  been 
created,  and  that  it  would  be,  in  fact,  as  if 
it  had  never  been  created.     Thus  he  not 


31 


only  failed  to  sustain  his  contention  that 
a  'depreciation  reserve '  was  necessary  for 
the  purposes  which  he  alleged,  but  he  pro- 
posed to  treat  the  reserve  as  if  he  himself 
believed  it  to  be  both  unnecessary  and  in- 
effectual, except  for  the  purpose  of  justi- 
fying a  deduction  from  the  complainant's 
investment. 

1 'It  is  obvious  that  the  collection  of  an 
unnecessary  reserve  and  its  periodic  deduc- 
tion from  the  value  of  the  property  in  ser- 
vice would  operate  to  effect  a  piece-meal 
purchase,  on  the  part  of  the  public,  of  the 
property  used  by  the  utility  in  its  service. 
In  other  words,  it  is  really  asking  the  con- 
sumer to  pay  for  the  plant,  instead  of  pay- 
ing a  return  on  the  investment.  If  such  a 
consummation  is  desirable,  of  which  there 
is  no  evidence,  it  should  be  effected  openly, 
and  not  surreptiously  under  the  guise  of 
providing  for  so-called  'theoretical  depre- 
ciation. ' 

"Present  Condition  of  the  Property 

"Mr.  Miller  testified  that  as  of  April, 
1920,  the  expenditure  of  $6,144.07  for  re- 
pairs, renewals  and  replacements,  would 
put  the  plant,  structures,  machinery  and 
equipment  in  condition  substantially  as 
good  as  when  they  were  erected  or  install- 
ed. His  testimony  in  this  respect  was  not 
contradicted  by  that  of  any  witness.  This 
sum,  however,  does  not,  in  my  opinion, 
measure  any  impairment  in  the  present 
value  of  the  property  used  and  useful  in 
the  gas  business.  It  represents  merely  an 
unmatured  obligation  to  maintain  the  prop- 
erty in  efficient  operating  condition  out  of 
future  earnings,  the  expert  witnesses  of 
both  the  complainant  and  the  defendants 
agreeing  that  it  was  and  is  maintained  in 
efficient  and  first-class  condition.  I  there- 
fore have  not  deducted  this  or  any  other 


32 

sum  representing  so-called  *  accrued  depre- 
ciation' from  the  amount  found  by  me  to 
represent  the  investment  of  the  complain- 
ant in  its  gas  property  upon  which  it  is  en- 
titled to  have  its  rate  such  as  to  yield  a 
reasonable  return. ' ' 

Judge   Hand's  Rejection  of  "Accrued   Depreciation" 
Theories 

The  " straight-line' '  theory  of  "depreciation" 
and  the  setting  up  of  "reserves"  and  deductions 
based  thereon,  have  also  been  emphatically  re- 
jected by  Judge  Learned  Hand,  in  the  United 
States  District  Court  for  the  Southern  District  of 
New  York  (Consolidated  Gas  Co.  vs.  Newton, 
267  Fed.,  231,  265;  P.  U.  E.  1920  F,  page  485). 
The  Special  Master  in  this  case  also  had  rejected 
the  claim  that  deduction  must  be  made  for  "ac- 
crued depreciation,"  in  ascertaining  present 
value,  and  embodied  findings  accordingly  in  his 
report  to  the  District  Court.  Judge  Hand,  who 
heard  the  case  in  the  District  Court,  sustained  this 
view  and  made  findings  accordingly  in  his  decree.* 
In  his  opinion  (267  Fed.  231,  265),  Judge  Hand 
also  said: 


♦On  March  6,  1922,  the  Supreme  Court  of  the  United 
States  unanimously  affirmed  Judge  Hand's  decree;  without 
modification  in  respect  of  any  of  his  findings.  The  opinion 
of  the  Court,  read  by  Mr.  Justice  McReynolds,  declared 
that  "The  Master's  Report  and  Opinion  disclose  careful 
and  intelligent  consideration  of  the  whole  matter."  It  will 
be  noted  that  the  Special  Master  in  this  case  was  the  same 
judicial  officer  whose  discussion  of  the  subject  of  "deprecia- 
tion" in  the  New  York  and  Queens  Gas  Company  case, 
quoted  on  pages  26  to  31  hereof,  ante,  was  contemporane- 
ously before  the  Supreme  Court  in  the  case  last  mentioned. 
In  his  report  and  opinion  in  the  Consolidated  Gas  Company 
case,  thus  commended  by  the  Supreme  Court,  the  Special 
Master  had  also  said: 

"Reasons  for  Rejecting  'Present  Reproduction  Cost' 
and  Claimed  Deduction  for  "Theoretical  Depre- 
ciation.' 

"In  arriving  at  the  value  of  the  property  necessarily 
used  in  the  gas  business  of  the  complainant  company, 


33 


"Maltbie  figured  a  *  straight-line'  depre- 
ciation of  three  and  a  half  millions,  for  all 
plants  and  holders.  This  was  necessarily 
a  conjecture,  based  upon  the  suposed  life 
of  the  plant ;  it  has  no  application  while  the 
plant  is  kept  up.    *    •    • 

"The  other  elements  of  depreciation  are 
for  mains,  about  one  million  five  hundred 
thousand  dollars,  and  services  and  meters, 
one  million  five  hundred  thousand  dollars. 
Any  depreciation  in  the  mains  appears  to 
me  quite  fanciful.  Little  said  that  the  life 
of  a  main  when  properly  buried  was  in- 


I  have  rejected  the  testimony  and  suggestions  of  the 
witnesses  for  the  defendants  that  I  ought  to  take  the 
investment  in  the  property,  less  a  large  amount  for 
'theoretical  depreciation.'  Much  has  been  said  and 
written  on  this  subject,  and  I  have  read  with  interest 
the  matter  which  has  been  called  to  my  attention.  I 
cannot  escape  the  view  that  a  property  used  for  the 
service  of  the  public  in  the  operation  of  a  public  utility 
such  as  a  gas  company,  if  kept  in  good  operating  con- 
dition, must,  in  the  nature  of  things,  be  worth  to  the 
public  at  least  the  amount  honestly  and  reasonably  put 
into  the  property.  Nor  can  I  escape  the  conclusion 
that  any  other  method  of  arriving  at  the  value  of  the 
property  used  in  the  public  service  must  tend  to  un- 
fairness, either  to  the  consuming  public  or  to  the  in- 
vestors in  the  public  utility  corporation. 

"Take  the  case  under  consideration:  I  have  found 
that,  starting  with  the  value  of  the  property  as  fixed 
and  agreed  upon  in  1884  and  the  issuance  of  stock  at 
par  upon  that  basis,  and  adding  to  that  sum  the 
amounts  expended  from  time  to  time  in  installing  new 
apparatus  and  facilities  in  existing  plants  and  con- 
structing new  plants  and  facilities,  and  then  deducting 
therefrom  the  cost  .of  the  property  withdrawn  from 
service  since  1884,  there  is  actually  and  reasonably 
invested  in  property  used  in  the  gas  business  of  the 
complainant  no  less  than  $71,054,351.14,  exclusive  of 
mobile  or  floating  assets,  commonly  called  working 
capital.  The  plant,  machinery  and  equipment  used  in 
the  gas  business  of  the  complainant  company  has  been 
and  is  maintained  in  excellent  operating  condition; 
proper  repairs,  renewals  and  replacements  have  been 
made  from  time  to  time,  and  the  same  are  now  in  zs 
high  a  state  of  efficiency  as  if  new.  From  every  point 
of  view  which  concerns  or  affects  the  consumers,  the 
property  for  which  this  $71,054,351.14  was  paid  is  ren- 
dering the  same  service  today,  and  in  some  instances  a 
little  better  service,  than  was  contemplated  or  secured 
at  the  time  the  money  was  put  in.  Nevertheless,  coun- 
sel for  the  defendants  insistently  urge  that  all  return 
must  now  be  withheld  from  a  large  part  of  that  invest- 


34 


definite;  the  only  question  is  of  obsolesc- 
ence and  repairs,  and  I  should  suppose 
that  obsolescence  would  occur  only  after 
it  got  too  small  for  its  requirements.  It 
might,  of  course,  be  possible  to  show  that 
all  necessary  mains  could  now  be  laid  for 
less  than  the  book  cost,  but  the  plaintiff  has 
shown  the  contrary  by  Miller,  and  it  is 
not  contradicted. 

"As  to  meters  and  services  the  case  is 
not  so  strong  because  even  if  their  life  be 
seventy-five  years,  as  Little  thinks,  no  one 
knows  the  age  of  all  those  in  use.    More- 


ment,  and  the  amount  of  investment  arbitrarily  re- 
duced, merely  because  some  of  the  plants  or  some  of 
the  property  in  them  have  been  in  existence  for  some 
years.  The  complainant  company,  on  the  other  hand, 
would  find  justification  in  the  decisions  of  the  Courts 
for  a  contention  that  the  value  of  this  property  must 
be  taken  as  of  the  present  time  and  that  I  must  fix 
this  value  upon  the  expert  opinion  as  to  the  cost  of 
reproducing  the  property  as  of  the  present  time,  in 
which  event  there  would  arise  the  question  whether 
from  such  reproduction  cost  should  be  deducted  the 
amount  of  any  observable  and  actual  deterioration  or 
depreciation. 

"As  I  have  found,  on  the  basis  of  the  prices,  rates 
of  Pay,  and  costs  prevailing  during  the  eight  months 
beginning  January  1,  1919,  the  cost  of  making  and  dis- 
tributing gas  has  been  such  as  to  allow  a  very  small,  if 
any  return,  on  even  the  actual  investment ;  and  since 
September  1,  1919,  the  cost  of  making  and  distributing 
gas  has  been  increased  in  a  number  of  respects  so  that 
the  fair  inference  is  that  the  complainant  company 
now  finds  itself  without  any  return  upon  the  invest- 
ment. The  conditions  found  by  me  have  existed  for 
more  than  a  year  last  past,  and  to  a  lesser  degree  for 
at  least  a  year  before  that  time,  and  will  continue  for 
at  least  a  considerable  period  of  time,  the  end  of  which 
cannot  now  be  forecast. 

"Upon  such  a  situation  and  such  a  prospect,  I  think 
that  the  complainant  company  has  shown  itself,  clearly 
and  beyond  all  reasonable  doubt,  entitled  to  relief  from 
the  statutory  limitation  on  its  rates,  but  that  its  rate 
of  return  should  be  calculated,  not  upon  the  present 
high  reproduction  cost  of  its  property,  with  or  without 
the  deduction  of  observed  or  actual  depreciation,  in 
whatever  manner  computed,  but  upon  the  actual,  rea- 
sonable investment  in  the  property  devoted  to  the 
service  of  the  complainants'  consumers.  Taking  the 
years  as  they  come  and  go,  of  high  construction  cost 
and  of  low  construction  cost,  the  amount  honestly  and 
actually  put  into  a  plant  and  system  of  this  character, 
represents  a  sum  which  fairly  and  reasonably  should 


35 


over,  the  depreciation  of  one  million  five 
hundred  thousand  dollars  is  only  about 
twelve  per  cent  of  their  cost.  However, 
the  same  rule  applies  as  before.  The  plain- 
tiff proved  the  cost  and  the  necessary  re- 
pairs to  bring  the  whole  plant  up  to  its  or- 
iginal condition.  It  proved  that  the  cost 
of  reproducing  fixtures  of  equal  capacity 
was  more  than  the  book  cost.  That  made 
a  case,  in  my  judgment,  which  was  proof 
against  any  theory  of  *  straight-line*  depre- 
ciation. The  allowance  for  repairs  might 
be  attacked  on  the  ground  that  the  condi- 
tion of  the  plants  and  fixtures  in  fact  re- 
quired inordinate  repairs,  but  that  was  not 
done.  In  accordance  with  the  principle 
which  I  have  tried  to  demonstrate  I  de- 
cline to  make  any  allowance  for  deprecia- 
tion." 

Age  of  a  Plant  "Not  a  Function  in  Rate  Base" 

On  the  broader  aspects  of  the  subject,  Judge 
Learned  Hand  had  occasion  to  consider  its  legal 
and  economic  aspects  in  the  light  of  the  more 
thorough  and  intelligent  investigation  which  re- 
cent experience  has  prompted,  and  he  stated  his 
conclusions  as  follows : 


be  taken  as  representing  a  minimum  of  its  value  to 
the  public  for  use  as  a  public  utility.  The  only  testi- 
mony offered  before  me  to  show  the  expenditure  which  x 
would  be  necessary  in  order  to  put  the  plant,  struc- 
tures, machinery  and  equipment  in  condition  substan- 
tially as  good  as  when  erected  or  installed,  was  that 
of  Alten  S.  Miller,  an  engineer  long  familiar  with  these 
plants,  now  vice-president  in  charge  of  construction 
work  for  the  Bartlett-Hayward  Company  of  Baltimore. 
He  testified  that  the  outlay  of  approximately  $322,000 
for  repairs,  renewals  and  replacements  would  accom- 
plish this  result.  For  the  reasons  already  reviewed,  I 
have  not  considered  this  sum,  or  any  other,  as  a  proper 
deduction  from  the  above-stated  value  of  property." 

The  portions  of  the  Special  Master's  opinion  in  the  Con- 
solidated  Gas  Company  case  which  we  have  italicized  above 
were  quoted  with  evident  approval  by  the  Supreme  Court, 
in  sustaining  the  findings  of  the  Special  Master  and  of  Judge 
Hand  in  the  District  Court. 


36 


"The  defendants  insist  upon  the  element 
of  depreciation  based  upon  an  allowance 
each  year  of  that  proportion  of  the  total 
value  which  a  year  bears  to  the  whole  life 
of  the  plant.  The  Supreme  Court  {Knox- 
ville  Water  Co.  vs.  Knoxville,  supra,  Min- 
nesota Rate  Cases,  supra)  has  recognized 
that  some  depreciation  is  a  proper  element 
in  estimating  the  'rate  base,'  but  has  not 
as  yet  authoritatively  settled  on  what  prin- 
ciple it  shall  be  calculated.  It  seems  to  me 
hardly  possible  in  the  case  at  bar  to  avoid 
taking  a  position  with  regard  to  that  prin- 
ciple. 

"If  the  proper  standard  for  a  'rate-base* 
is  the  present  cost  of  a  substitute  plant  of 
equal  capacity,  as  I  believe,  depreciation 
can  be  a  function  of  it  only  in  case  the  al- 
lowance for  renewals  to  the  plant  under 
consideration  will  in  the  future  be  greater 
than  that  of  the  assumed  standard.  If  the 
rates  allowed  in  the  future  include  only  an 
allowance  for  renewals  of  a  new  plant  the 
company  will  have  to  abate  something  from 
its  normal  profits  because  of  its  extraor- 
dinary renewal  charges.  Theoretically  it 
makes  no  difference  whether  this  problem 
is  met  by  giving  the  plant  a  smaller  value 
at  present  because  of  its  future  greater 
renewal  charges  and  then  allowing  a  higher 
rate  for  renewals,  or  by  giving  it  its  pres- 
ent value  based  on  capacity  and  letting  it 
bear  its  extra  renewals  out  of  its  normal 
profits.  Were  the  plant  sold,  the  future  ab- 
normal renewals  would  be  reflected  in  the 
sale  price,  being  discounted  at  once,  but 
that  would  be  because  the  parties  must  at 
present  clear  their  accounts  once  and  for 
all.  The  seller  would  be  unwilling  at  once 
to  abate  from  his  price,  and  later  to  allow 
the  buyer  from  time  to  time  for  his  unusual 
renewals.  In  the  case  of  a  public  service 
company  where  the  authorities  may  always 
require  the  plant  to  be  kept  up  to  stand- 


37 


ard,  there  is  an  obvious  advantage  in  de- 
clining to  attempt  a  repeated  adjustment 
between  the  actual  renewals  necessary  and 
normal  renewals,  as  would  be  necessary  if 
the  present  prospect  of  such  allowances 
were  now  discounted ;  it  is  the  better  prac- 
tice to  allow  the  plant  to  bear  its  own  ex- 
tra renewals  and  to  insist  that  it  shall  al- 
ways be  kept  up.  Therefore,  it  appears 
that,  so  far  as  concerns  the  future,  the  age 
of  the  plant  should  not  be  a  function  in  the 
'rate-base.7 

"On  the  other  hand,  in  computing  the 
'rate-base*  from  the  original  cost,  deprecia- 
tion is  of  vital  consequence.  Practical  men 
will  prefer  to  ascertain  the  cost  of  a  pres- 
ent plant  by  experience,  when  they  can, 
rather  than  by  estimate,  just  as  the  master 
here  has  done.  In  so  arriving  at  the  cost 
of  a  present  plant  of  equal  capacity,  it  is 
clear  that  the  original  cost  of  the  plant  in 
question  must  be  abated  by  depreciation, 
so  far  as  that  is  reflected  in  a  loss  of  capac- 
ity. In  such  a  calculation,  however,  there 
must  figure  past  renewals  as  an  offset  to 
past  depreciation  and  if  in  fact  the  capacity 
has  remained  the  same,  depreciation  should 
not  be  a  function  of  the  'rate  base'  at  all. 
In  such  a  case  the  inquiry  as  to  deprecia- 
tion should  be  confined  to  changes  in  ■  price- 
levels.'  " 

There  being  no  loss  of  capacity  to  serve,  in  the 
case  of  the  rolling-stock,  road-bed,  terminals, 
round-houses,  and  other  property  and  equipment 
of  a  railway  common  carrier,  through  lapse  of 
time,  but  probably  rather  an  increase  in  capacity 
and  efficiency  over  previous  years,  and  the  prop- 
erty being  in  fact  maintained  in  repair  and  ex- 
cellent operating  condition,  as  the  statute  re- 
quires, there  is  no  sound  reason  to  set  up  and 
accrue  any  sum  for  "accrued  theoretical  depre- 
ciation" or  to  require  that  this  be  done. 


38 


The  New  York  State  Court  Refuses  to  Deduct 
"Depreciation" 

The  views  expressed  in  the  foregoing  decisions 
in  the  Federal  Court  have  f  onnd  agreement  in  the 
only  subsequent  ruling  in  the  New  York  State 
Courts.  In  New  York  &  Richmond  Gas  Co.  vs. 
Nixon,  decided  January  10,  1921,  Ex-Justice  Al- 
bert H.  Sewell,  for  many  years  a  member  of  the 
Appellate  Division  of  the  New  York  Supreme 
Court,  refused  to  make  any  deduction  for  any 
manner  of  so-called  " depreciation,' '  in  fixing 
the  value  of  the  property  of  a  gas  company,  upon 
which  he  held  the  company  constitutionally  en- 
titled to  earn  a  fair  return. 

The  Recent  Decision  of  the  Circuit  Court  of  Appeals 
in  the  Nashville  Case 

Illustrative  of  the  general  disposition  of  Courts 
and  regulatory  authorities  to  make  a  re-examina- 
tion of  this  whole  subject  in  the  light  of  the  de- 
veloped experience  of  public-service  enterprises 
is  the  decision  of  the  United  States  Circuit  Court 
of  Appeals  for  the  Sixth  Circuit,  on  December 
7, 1920,  in  Nashville  C.  &  St.  L.  By.  Co.  vs.  United 
States  (269  Fed.,  351).  In  that  case,  the  railway 
company  had  computed  "depreciation"  of  road- 
way for  the  two  years  in  question  by  the  so-called 
"straight-line"  method,  taking  three  per  cent,  of 
the  value  thereof  as  annual  depreciation  on  the 
theory  that  the  average  life  of  the  perishable  ele- 
ments was  thirty-three  and  one-third  years,  and 
had  deducted  the  amount  from  gross  income.  The 
Government's  contention  was  that  there  was  no 
net  depreciation  in  the  intrinsic  value  of  the  road- 
way and  structures  considered  as  a  unit  and  that 
the  deduction  should  not  have  been  made.  The 
Circuit  Court  of  Appeals  sustained  this  view, 


39 


quoting  with  approval  the  testimony  of  witnesses 
that  "  there  may  be  depreciation  in  the  units  com- 
prising the  roadway,  track  and  structures  of  the 
railroad,  while  there  is  no  depreciation  in  the 
machine  as  a  whole";  also  that  it  is  possible  "to 
maintain  the  roadway,  track  and  structures  so 
that  there  will  be  no  depreciation  if  we  consider 
the  roadway,  track  and  structures  as  a  composite 
whole";  also  that  "the  service  life  of  any  nor- 
mally operated  and  well  maintained  railroad  is 
perpetual  and  it  is  maintained  in  the  condition  of 
property  serving  its  purpose  by  annual  renewals 
and  replacements." 

Contentions  of  the  Government  in  the  Nashville  Case 

The  views  expressed  in  this  memorandum  were 
not  those  of  a  utility  corporation  seeking  to  ob- 
tain a  return  on  its  investment  unimpaired  by  fic- 
titious depreciation.  The  contention  is  that  re- 
cently urged,  successfully,  by  the  Government  of 
the  United  States,  in  the  above  case.  Of  great 
interest  in  connection  with  the  foregoing  decision 
of  the  Circuit  Court  of  Appeals  are  the  following 
excerpts  from  the  brief  filed  in  behalf  of  the 
United  States,  by  way  of  reply  to  the  contentions 
of  the  brief  submitted  in  behalf  of  the  railroad 
company : 

"The  Government  admits  that  there 
would  have  been  depreciation  to  the  road- 
way of  the  railway  for  the  years  1909  and 
1910  after  all  reasonable  and  proper  re- 
pairs merely  had  been  made;  but  the  Gov- 
ernment proved  that  the  renewals  and  re- 
placements, together  with  the  repairs  which 
were  made,  maintained  the  roadway,  and, 
in  fact,  kejpt  the  roadway  in  as  good  or  bet- 
ter condition  at  the  end  of  each  of  said 
years  as  it  was  in  at  the  beginning  of  each 
of  said  years,  and  that  therefore  there  was 


40 


"It  is  the  theory  of  the  Government  that 
the  usefulness  of  roadways  determines 
their  value  in  use.  In  other  words,  as  their 
usefulness  is,  so  is  their  value.  //  their 
usefulness  remains  the  same,  their  value 
also  remains  the  same;  if  their  usefulness 
is  increased,  their  value  is  correspondingly 
increased ;  if  their  usefulness  is  decreased, 
their  value  is  likewise  decreased.  It  is  ob- 
vious, therefore,  that  whatever  increases  or 
reduces  the  usefulness  of  railroads,  cor- 
respondingly increases  or  reduces  their 
value.  In  this  connection,  it  is  well  known 
that  wear  and  tear,  etc.,  reduce  the  use- 
fulness, and  consequently  the  value  of  rail- 
roads. On  the  other  hand,  it  is  equally 
well  known  that  repairs,  renewals  and  re- 
placement of  parts  increase  the  usefulness 
and  consequently  the  value  of  railroads.  It 
is  also  well  known  that  the  occurrence  of 
wear  and  tear  is  the  occasion  for  repairs, 
renewals  and  replacements  of  parts,  and 
that,  with  the  roadway  and  other  property 
properly  managed,  railway  companies' 
wear  and  tear  no  sooner  occurs  than  re- 
newals and  replacements  are  made — so  that 
both  take  place  simultaneously  and  tend  to 
counteract  or  offset  each  other. 

"When  this  occurs,  i.  e.,  where  wear 
and  tear  suffered  by  railroads  is  sought  to 
be  offset  or  counteracted  by  repairs,  re- 
newals, and  replacements  of  parts,  one  of 
three  results  must  happen.  First,  if  the 
wear  and  tear  is  exactly  offset  or  counter- 
acted by  repairs,  etc.,  the  usefulness  and 
value  of  the  railroad  remains  the  same  and 
the  value  is  said  to  be  'maintained'  intact. 
Second,  if  the  wear  and  tear  is  not  entirely 
overcome  by  the  repairs,  etc.,  the  useful- 
ness and  value  are  reduced  and  the  value 
is  said  to  be  'depreciated'  to  the  extent  of 
the  difference  between  the  original  and 
present  value  of  the  railroad.  Third,  if 
the  wear  and  tear  is  more  than  overcome 


41 


by  repairs,  renewals,  etc.,  the  usefulness 
and  value  is  *  increased  *  and  the  increased 
value  is  regarded  as  'an  additional  capi- 
tal investment. ' 

"  Counsel  for  the  railway,  on  page  44  of 
its  brief,  says: 

'The  fallacy  in  the  Government's  the- 
ory is,  first,  that  it  considers  "better- 
ments" as  a  means  of  offsetting  depre- 
ciation. This  cannot  properly  be  done; 
sums  for  betterments  are  charged  to 
capital  account,  not  operating  ex- 
penses.' " 

The  Government  Proved  There   Is  No  Ac- 
crued Depreciation"  of  Railway  Property 

"The  Government  did  not  consider  bet- 
terments as  a  means  of  offsetting  depre- 
eiation  when  sums  expended  for  better- 
ments were  charged  to  the  capital  account 
of  the  railway.  The  Government  proved 
that  it  is  an  established  policy  of  Ameri- 
can railways  not  only  to  maintain  but  to 
improve  the  usefulness  and  value  of  their 
roadways;  and  to  accomplish  this  end,  it 
is  their  practice  to  make  repairs,  renewals, 
and  replacements  of  parts  as  occasion  re- 
quires, and  that  as  a  result  of  such  policy 
and  practice,  railways  prevent  or  overcome 
depreciation  in  the  value  o\f  their  roadways 
as  a  whole  and  continue  the  service  life  of 
their  roadways  indefinitely.  Materials  of 
a  more  modern  and  improved  type  are  con- 
stantly being  used  in  effecting  renewals  and 
replacements  of  a  roadway  which  actually 
constitute  an  improvement  or  betterment 
which  is  not  usually  shown  on  the  books,  as 
will  be  shown  from  Mr.'Isbell's  testimony, 
on  pages  43  and  44,  which  is  as  follows: 

*I  do  not  think  the  deduction  made  by 
the  railway  for  depreciation  of  its  road- 
way should  be  allowed  because  in  these 


42 


charges  for  maintenance  of  roadway  are 
included  items  for  renewals  and  replace- 
ments. Under  the  income  tax  law,  re- 
newals and  replacements  should  be 
charged  not  against  expenses,  but  should 
be  taken  from  a  depreciation  reserve,  if 
such  a  reserve  is  on  the  books.  It  could 
not  be  taken  from  a  depreciation  reserve 
unless  such  reserve  does  appear  on  the 
books.  Then  it  is  not  an  allowable  ex- 
pense or  deduction  on  the  income  or  ex- 
cise tax  returns,  for  the  reason  that  this 
renewal  or  replacement  keeps  the  prop- 
erty to  its  original  value.  As  to  what  I 
mean  by  original  value,  when  the  railroad 
replaces  any  item,  they  try  to,  according 
to  my  experience,  make  it  as  good  or  bet- 
ter. For  instance,  if  a  cross-tie  is  re- 
placed, if  they  can  get  a  better  cross-tie 
to  put  in  there,  they  do  it.  In  the  matter 
of  what  is  technically  known  as  other 
track  material,  consisting  of  such  things 
as  switches  and  frogs  and  things  like  that, 
they  try  to  put  in  a  better  one  if  they 
have  to  replace  an  old  one;  they  try  to 
put  in  better  ballast,  if  possible.  In  that 
way  they  not  only  effect  a  renewal,  but 
they  have  an  improvement  or  betterment 
which  is  not  usually  shown  on  the  books. 
Of  course,  if  they  build  additional  track- 
age, that  is  charged  to  capital  account, 
and  is  an  addition  or  betterment,  and 
that  does  not  enter  into  this  question 
whatever.    *    *    * 


'When  a  tie  is  played  out,  a  new  tie  is 
put  in  place.  That  is  called  a  renewal  or 
replacement.  In  the  same  way,  if  a  de- 
pot needs  to  be  rebuilt,  and  about  the 
same  character  of  structure  is  to  be  built, 
that  is  called  a  renewal  or  replacement 
of  the  depot,  and  the  same  thing  is  true 
of  a  trestle.  If  the  trestle  is  replaced 
as  near  as  possible  at  about  the  same  cost 


43 


as  the  old  one,  that  is  called  a  renewal  or 
replacement  of  that  bridge  or  trestle. 

'If  an  additional  track  is  built,  for  in- 
stance, a  branch  line  is  built  to  a  new 
town  or  new  territory,  even  if  it  is  one 
mile  or  fifty  miles  long,  that  is  called  an 
addition  or  betterment.  If  a  bridge  cost- 
ing $10,000  is  replaced  by  a  new  one  cost- 
ing $20,000,  then  $10,000  is  a  renewal  and 
charged  to  operating  expenses,  and  the 
additional  $10,000  is  an  addition  or  bet- 
terment, and  that  goes  into  the  capital 
It  is  not  charged  as  an  expense  against 
the  gross  income  for  one  year.*  " 

The  Contention  of  the  Government  as  to  the 
Effect  of  Renewals  and  Replacements 

"Counsel  for  the  railway  states  on  page 
45  of  its  brief  as  follows : 

*  The  Government  gave  no  considera- 
tion to  such  repairs  as  painting  a  depot, 
putting  windows  in  machine  shops,  fixing 
the  floor  of  a  section  house — that  class  of 
repairs  that  prolong  the  life  of  the  unit 
repaired  but  cannot  totally  arrest  its  de- 
preciation. ' 

"Mr.  Isbell,  one  of  the  Government's 
witnesses,  in  his  answer  to  the  following 
question  in  regard  to  repairs  to  depots, 
shows  very  plainly  that  repairs  are  taken 
into  consideration  (see  Tr.,  page  47) : 

*Q.  If  a  railroad  company  repairs  a 
depot,  by  painting,  for  instance,  will  that 
arrest  the  functional  depreciation  that  is 
accruing  daily  to  take  care  of  increased 

business  in  the  future! 

'A.  It  arrests  the  deterioration  of  the 
plant.  It  replaces  the  paint.  It  would 
not  arrest  the  depreciation  of  any  other 
part.  That  would  be  arrested  when  that 
other  particular  part  might  be  re- 
paired.* " 


44 


method  of  depreciation  could  possibly  be 
proper  and  onlv  basis  upon  which  any  sane 
property,  made  up  of  individual  units,  the 

"Since,  as  Mr.  McKeand  stated,  a  rail- 
road property  is  of  necessity  a  composite 
figured  would  be  upon  the  composite  prop- 
erty and  not  upon  the  millions  of  individual 
units  which  go  to  make  up  the  composite 
property. 

"In  other  words,  as  aptly  expressed  by 
the  learned  Trial  Judge,  in  his  charge: 

*I  further  charge  you,  as  a  matter  of 
law,  construing  this  statute,  that  in  that 
sense  you  should  not  consider  each  of 
the  individual  units  that  enter  into  the 
roadway.  It  was  not  intended  to  have  a 
system  of  bookkeeping  with  reference  to 
each  particular  cross- tie  or  each  partic- 
ular rail,  but  you  should  look  to  the  value 
of  the  roadway  as  a  whole,  comparing 
its  value  at  the  beginning  of  the  year  with 
its  value  at  the  end  of  the  year'  (Tr., 
page  104). 

"If  the  statement  of  counsel  for  the  rail- 
way that  'it  is  undisputed  that  functional 
depreciation  cannot  be  arrested,  retarded 
or  offset  by  repairs,  renewals  or  replace- 
ments '  were  correct,  then  it  would  neces- 
sarily follow  that  no  matter  how  much 
money  was  expended  each  year  on  any  road- 
way, then  it  would  be  impossible  to  prevent 
that  roadway  from  at  some  time  becoming 
absolutely  worthless,  and  it  would  have  to 
be  abandoned  at  some  time  in  the  future. 
It  is  a  matter  of  common  knowledge  that 
such  a  catastrophe  never  occurs,  and  that 
if  a  railway  is  properly  maintained  from 
day  to  day  and  month  to  month,  and  year 
to  year  by  the  expenditure  of  proper 
amounts  in  making  repairs,  renewals  and 
replacements,  that  the  life  of  the  roadway 
is  perpetual  and  that  the  roadway  will 


45 

never  have  to  be  junked  as  a  whole  or  en- 
tirely rebuilt." 

•  •••••• 

"Since  the  railway  has  admitted  that  its 
railroad  is  a  well  maintained  railroad,  and 
since  one  of  its  experts,  who  was  called  as  a 
witness  for  the  railway  in  its  behalf,  has 
suggested  that  'the  service  life  of  any  nor- 
mally operated  and  normally  and  well  main- 
tained railroad  is  perpetual,  and  it  is  main- 
tained in  the  condition  of  properly  serving 
its  purpose  by  annual  renewals  and  replace- 
ments,' it  is  apparent  that  the  service  life 
of  the  N.,  C.  &  St.  L.  By.  is  perpetual  and 
that  the  repairs,  renewals  and  replacements 
which  were  made  to  it  during  the  years  1909 
and  1910  eliminate  both  functional  and  phy- 
sical depreciation  or  any  other  kind  of  de- 
preciation which  would  have  taken  place 
had  it  not  been  for  the  repairs,  renewals 
and  replacements  which  were  made,  as  tes- 
tified to  by  its  Chief  Engineer,  Mr.  Hunter 
McDonald." 

The  Rulings  of  the  Department  of  Internal  Revenue 

Age  alone  has  no  effect  upon  the  units  of  a  gas 
plant.,  They  may  wear  out  in  the  process  of  time 
if  not  repaired;  they  may  rust  out  if  provisions 
against  rust  are  not  made;  or  units  may  become 
obsolete  in  the  course  of  time.  But  where  repairs 
are  made  continuously,  where  the  plant  units  are 
painted  and  otherwise  preserved  against  the  in- 
vasion of  rust,  and  where  small  units  are  replaced 
from  time  to  time,  there  is  no  depreciation  of 
units  which  are  not  commonly  replaced  as  repairs, 
nor  exhaustion  of  the  plant  itself  by  the  continual 
replacement  of  its  units.  And  in  the  case  of  obso- 
lescence, which  is  the  cause  of  95  per  cent,  of  all 
replacements  in  a  gas  plant,  it  cannot  be  assumed 
that  the  value  of  the  retired  unit  has  proceeded 


46 


progressively  and  step  by  step  with  the  progress 
of  time,  but  on  the  contrary,  the  depreciation  of 
such  retired  units  occurs  all  at  once  at  the  time 
when  they  are  retired,  or  at  least,  at  the  time  when 
their  retirement  becomes  certain  and  imminent. 
This  is  the  ruling  of  the  Internal  Bevenue  Board 
of  the  Treasury  Department.  Thus  one  ot  the 
office  decisions  of  the  Bureau  (Bulletin  35  of  1921, 
page  21)  is  as  follows: 

"In  order  that  a  taxpayer  may  be  al- 
lowed a  deduction  for  obsolescence  at  any 
given  period,  it  is  essential  that  the  use  of 
the  property  should  have  been  abandoned 
during  such  period  or  that  it  become  certain 
that  the  property  must  be  abandoned  at  a 
definite  future  date." 

The  Bureau  does  not  recognize  any  prophetic 
gifts  in  taxpayers  that  would  enable  them  to  fore- 
tell at  what  date,  if  ever,  in  the  remote  future, 
improvements  in  the  art  may  justify  retirement 
for  obsolescence,  nor  may  the  Court  or  Commis- 
sion properly  indulge  in  such  speculations,  even 
based  upon  the  assertions  *  of  "public  utilitv  con- 
sultants." 

The  Kansas  District  Court  Rejects  "Theoretical 
Depreciation" 

In  Landon  vs.  Court  of  Industrial  Relations 
(269  Fed.  433,  445),  District   Judge   Booth   ex- 


•As  illustrative  of  the  flimsy  basis  on  which  "estimates" 
of  "accrued  theoretical  depreciation"  are  predicated,  and  the 
lack  of  experience,  qualifications,  or  sound  definition,  which 
characterize  the  efforts  to  accomplish  this  deduction  from 
invested  capital,  the  following  is  quoted  from  the  brief  in 
behalf  of  the  complainant  gas  company  before  the  United 
States  Supreme  Court,  in  Consolidated  Gas  Company  vs. 
Newton.  (See  foot-note  on  page  32,  ante.)  The  references 
are  to  the  printed  record  in  that  case: 

"Appellants'  witness  Bemis  defined  depreciation  as 
follows  (f ol.  40753) : 


47 


pressed  the  prevailing  tendency  to  reject  "the- 
oretical depreciation* '  in  all  forms: 

*t  •  •  •  jn  mv  judgment  the  element  of 
depreciation  should  not  be  measured  by  a 
theoretical  yardstick,  but  should  be  deter- 
mined by  a  careful  consideration  of  the 
actual  facts  touching  the  physical  condition 
of  each  particular  plant  under  considera- 
tion.' ' 

The  Recent  Decision  in  the  Pacific  Gas  and  Electric 
Company  Case. 

The  reports  filed  by  Ex-Judge  H.  M.  Wright  in 
Contra  Costa  Water  Co.  vs.  City  of  Oakland  (113 
Pac  668)  and  in  Spring  Valley  Water  Co.  vs.  San 

'The  loss  of  service  life.    The  loss  in  life  or  serv- 
iceableness,  or  life  in  service  of  a  part  or  all  of  the 
property.' 
"This  definition  could  not  be  correct  because  loss  of 
life  cannot  be  deducted  from  value  new.    Furthermore, 
since  ninety-five   per  cent  of  the  units  of  plant  and 
equipment  are  displaced  because  of  obsolescence  or  in- 
adequacy and  not  because  of  wear  and  tear,  it  is  obvi- 
ous that  the  service  life  of  a  new  unit  just  installed  is 
no  greater  than  that  of  a  well  maintained  correspond- 
ing unit  which   has  been  in  service  for  many  years. 
The  'serviceableness'  of  both  is  identical ;  likewise  their 
service  value,  though  the  amount  invested  in  each  may 
differ  because  of  a  change  in  price. 

"Appellants'  witness  Maltbie  defined  depreciation  as 
follows  (fol.  39841): 

'It  is  the  decrease  in  worth  or  value  due  to  all 
causes,  such  as  wear  and  tear,  decay,  obsolescence 
and  inadequacy.' 

"He  did  not  explain  whether  or  not  he  distinguished 
'worth'  from  'value.'  If  he  intended  that  by  'worth'  he 
referred  to  physical  qualaities,  and  that  by  'decrease  of 
worth'  he  meant  deterioration,  that  part  of  this  defini- 
tion is  clear  error,  in  a  rate  case,  because  physical  qual- 
ity cannot  be  deducted  from  value  new,  represented  by 
an  amount  of  money.  Therefore  we  are  concerned 
only  with  his  definition  of  depreciation  as  'decrease 
in  value.' 

"But  an  author  or  writer  may  begin  by  a  neatly 
rounded  definition  and  blithely  forget  it  the  next  min- 
ute. It  is  necessary  to  examine  the  witness'  testimony 
to  find  what  he  really  means.  Mr.  Maltbie  said  (fol. 
39,951): 

"When  you  start  out  with  anything  there  is  a  cer- 
tain amount  of   service  it  will  render,   and   it  has 


48 


Francisco  (252  Fed.  979)  (1918),  were  formerly 
cited  with  frequency  as  giving  support  to  the  in- 
clusion of  provision  for  ''accrued  theoretical  de- 
preciation" in  utility  rates  and  the  deduction  of 
the  estimated  amount  of  such ' '  depreciation ' '  from 
the  sum  on  which  the  fair  return  to  be  earned  by 
the  utility  would  otherwise  be  computed.  Those 
who  cite  these  earlier  discussions  from  the  erudite 
pen  of  Judge  Wright  overlook  the  conclusions  of 
his  elaborate  report  as  Special  Master  in  Pacific 
Gas  and  Electric  Co.  vs.  City  and  County  of  San 
Francisco,,  filed  March  2,  1920  (Northern  District 


value  because  it  will  render  that  service.  Now,  as 
time  goes  on  the  amount  of  remaining  service  which 
that  thing  will  render  decreases  as  you  go  along, 
and  consequently  the  value  of  that  commodity  or 
article  or  plant,  whatever  it  may  be,  decreases  in 
value  because  the  person  who  owns  it  has  a  shorter 
and  shorter  time  to  get  service  out  of  that  plant,  or 
anything.' 

"As    above    indicated    this    is    mere    plausible    cas- 
uistry. 

"We  shall  discuss  concretely  on  pages  435  to  447 
the  illustrations  used  by  this  witness  and  their  fallacy. 
"Appellants'  witness  Hine,  who  made  the  computa- 
tions of  alleged  depreciation  in  the  appellee's  plant  and 
equipment,  denned  depreciation  as  follows: 

'Loss  in  worth  or  value  due  to  all  the  causes,  such 
as  decay,  wear  and  tear,  obsolescence,  inadequacy, 
and  so  forth'  (fol.  40,157). 

"By  'value,'  he  meant  'value  for  the  purpose  of  rate 
regulation'  (fol.  40,166),  which  is  apparently  any 
amount  which  some  one  wishes  'value'  to  be.  He 
speaks  of  'depreciated  cost'  (fol.  40,169),  a  nonsensical 
juxtaposition  of  words.  As  to  this,  Judge  Hand  said, 
on  the  argument,  to  appellants'  counsel: 

'You  cannot  go  into  depreciation  and  you  cannot 
go  into  obsolescence  and   still   keep  the  theory  of 
cost,  because  if  you  do,  this  is  a  confusion  of  prin- 
ciple.   *    *    *    You  are  trying  to  eat  your  cake  and 
have  it;  you  are  taking  it  with  one  hand  and  refusing 
to  give  with  the  other  what  the  principle  you  invoke 
requires.' 
"In  making  his  estimate  of  depreciation,  Hine  did 
not   consider  the    physical   condition   of   the  property 
(fols.  40,152,  40,129).     He  based  his  estimates  wholly 
on  the  age  of  the  property,  although  admitting  that 
if  he  looked  at  two  engines  of  different  ages,  he  could 
not   tell   which   was   the   older   (fol.  40,290).     To  ex- 
hausters he  attributed  a  life  of  from  15  to  25  years, 
but  he  never  knew  of  an  exhauster  retired  for  age  only 
(fol.  40,292).     What  he  did,  as  a  result  of  reading  his 


49 


of  California),  to  which  District  Judge  Rudkin,  on 
June  3,  1921,  dismissed  the  exceptions,  upholding 
the  Special  Master's  findings  (273  Fed.  937). 

In  the  case  just  cited,  Judge  Wright  expressed 
the  view,  now  becoming  general,  that  in  the  light 
of  business  and  engineering  experience  and  the 
literature  of  the  subject,  including  recent  judicial 
decisions,  the  whole  matter  of  "depreciation"  and 
earlier  rulings  concerning  it,  must  be  considered 
anew.  He  concluded  that,  in  a  rate  case,  the  mat- 
ter of  so-called  "depreciation"  is  "a  false  quan- 

whole  testimony,  was  to  assign  a  period  of  life  to  each 
plant  unit,  to  ascertain  its  cost,  as  nearly  as  possible, 
and  then  to  assume,  without  explanation,  that  the  de- 
preciation is  equivalent  to  such  a  proportion  of  the  cost 
as  the  expired  life  bears  to  the  estimated  life. 

"Hine  considered  that  the  life  of  a  unit  began  at 
the  time  any  money  was  spent  for  it  and,  in  this 
manner,  he  estimated  that  one  of  the  plants  was  three 
years  old  and  had  depreciated  accordingly,  before  it 
was  even  completed  and  had  begun  to  operate  (fol. 
40,183). 

"In  the  case  at  bar,  the  Master  and  District  Court 
have  found  as  a  fact  that  utility  plants  and  property 
do  not  wear  out,  deteriorate,  or  lose  value  because  of 
the  progress  of  time.  The  Master  and  the  Court  have 
found  as  a  fact  that  no  such  depreciation  or  deteriora- 
tion has  in  fact  taken  place  as  to  the  appellee's  plants 
and  properties. 

"Mr.  A.  S.  Miller,  vice-president  of  the  Bartlett- 
Hayward  Company,  one  of  the  most  experienced  con- 
struction engineers  in  the  gas  industry  in  the  country, 
made  a  report  of  the  results  of  his  detailed  examina- 
tion into  the  condition  of  the  appellee's  plants  and 
properties.  He  found  them  in  a  high  state  of  repair 
and  first-class  operating  condition.  For  the  sum  of 
$322,000  (or  about  J4  of  1  per  cent  of  the  investment) 
he  was  willing  to  take  a  contract  to  put  the  plants  and 
property  in  substantially  as  good  condition  as  when 
first  erected  or  installed  (Record,  page  7620  et  seq.). 

"The  items  and  details  of  his  estimate  were  set  out 
in  his  report,  and  this  testimony  as  to  the  actual  con- 
dition and  the  sum  required  for  the  restoration  to  con- 
dition new,  was  uncontradicted  (Record,  page  69a). 

"Upon  what  testimony  do  the  appellants  ask  this 
Court  to  overturn  the  fact-findings  of  the  Court  below? 
None  of  the  appellants'  witnesses  took  any  account  of 
the  actual  physical  condition  of  the  plants  (fols.  40,152, 
40,  129) : 

"The  Witness  Hine,  in  so  far  as  his  practical  ex- 
perience was  concerned,  had  never  risen  above  the 
grade   of  'cadet    engineer.'     As  we  have   seen    (pages 


50 

tity,"  and  that  the  real  question  is  "When  shall 
the  charges  to  provide  funds  for  replacement  be- 
gin and  end?" 

He  said: 

"Unlike  tables  of  human  mortality, 
tables  of  the  mortality  of  structural  ele- 
ments, founded  on  the  experience  of  plants 
all  over  the  country,  or  a  table  of  abandon- 
ment* in  the  plant  under  examination,  will, 
all  alike,  be  unsafe  guides  for  prediction 
of  future  experience.  For  certainly,  to  the 
extent  that  past  abandonments  have  oc- 
curred by  reason  of  obsolescence  or  inade- 
quacy, there  can  be  no  uniform  rule,  in  the 
nature  of  things,  and  therefore  no  guide 
for  forecast  of  the  future* '  (page  45). 


363-365;  372-373,  ante),  he  did  not  profess  to  have  per- 
sonal knowledge  to  sustain  his  judgment  and  opinion 
respecting  the  life  expectancy  of  the  various  classes  of 
plant  and  equipment.  His  'life-tables'  were  mere  guess- 
work or  gathered  from  the  conclusions  of  other  per- 
sons as  reckless  regarding  facts  or  as  lacking  in  quali- 
fications as  was  Hine  himself.  His  formula  was  that 
of  his  partner  Maltbie;  beyond  that  he  did  not  go  and 
could  not  know. 

"The  Witness  Maltbie  made  no  profession  of  being 
anything  but  an  academician.  He  had  never  operated 
or  managed  any  plant,  property  or  project,  or  had 
experience  in  the  administration  of  the  financial  affairs 
of  any  undertaking  of  any  kind.  His  sole  asset  was 
his  formula  for  computing  a  wholly  theoretical  depre- 
ciation based  upon  an  absurd  hypothesis  of  life  ex- 
pectancy. All  he  required  was  that  some  one  should 
provide  him  with  something  which  might  be  taken  as 
the  'historical'  cost  if  actual  cost  was  too  high  for  his 
purposes — of  the  plant  and  equipment  he  was  hired 
to  depreciate,  and  then  he  would  sit  in  his  library  and 
apply  his  hypothetical  formula,  sustaining  it  by  com- 
paring a  gas-plant  (which  will  operate  for  centuries)  to 
a  wood-pile  disappearing  under  daily  removals  (see 
pages  415  to  427,  post). 

"The  Witness  Bemis  frankly  admitted  (Record, 
page  13,609)  his  utter  lack  of  experience  in  the  man- 
agement and  handling  of  analogous  properties  and 
projects.    He,  too,  had  only  a  theory  and  a  formula. 

"Whatever  may  have  been  the  opinion  of  the  Court 
in  the  Knoxville  case  as  to  the  necessity  of  the  crea- 
tion of  a  depreciation  reserve  accumulating  in  amount 
pari  passu  with  the  expiration  of  life  of  each  plant 
unit,  that  opinion  is  controverted  by  the  facts  of  the 
record  in  this  case. 


51 


The  Basis  of  the   1920  Grant  of  Increased  Freight 

Rates 

The  Interstate  Commerce  Commission,  in  grant- 
ing the  increase  in  freight  rates  effective  last 
August  (Re  Increased  Freight  Rates,  1920,  58 
I.  C.  C,  220),  was  required,  as  we  understood  it, 
to  determine,  in  accordance  with  paragraph  3  of 
Section  15-A  of  the  Interstate  Commerce  Act,  as 
then  recently  amended,  "the  aggregate  property 
value* '  of  the  railroads,  upon  which  a  percentage 
constituting  a  fair  return  was  to  be  earned  under 


"The  appellee  has  been  in  business  since  1884.  It 
has  never  had  a  depreciation  reserve;  it  has  never 
found  one  necessary  (see  testimony  quoted  on  pages 
461-70,  post).  Witnesses  for  the  appellee  testified  that 
such  a  reserve  as  is  contended  for  by  the  appellants  is 
in  fact  unnecessary. 

"Appellants'  theories  are  contradicted  by  three  basic 
facts  of  the  industry,  as  appears  from  the  testimony, 
viz.: 

"(1)  The  plant  and  property  of  a  well-maintained 
gas  corporation,  and  of  the  appellee  corporation  in 
particular,  does  not,  in  fact,  wear  out,  deteriorate  or 
lose  value  by  the  progress  of  time. 

Miller:     Record,  fol.  22,816,  23,030,  23,073,  23,117, 

23,134,  23,155,  23,242  23,381,  23,397. 
Mayer:    Record,  fols.  21,312,  21,462,  21,958. 
Allison:      Record,    fols.    24,485,    24,498,    24,513    to 

24,536. 
Simpson:    Record,  fols.  20,717,  20,933. 
Woods:    Record,  page  4762,  et  seq. 
"The  plants  and  properties  of  the  appellee  are  in 
fact  in  high   state  of  repair  and  first-class  operating 
efficiency,  yielding  results  as  good  or  better  than  when 
the  plants  were  first  built. 

Woods:     Record,  page  4752  et  seq. 
Miller:     Record,  page  7613. 

Hine    (witness    for   defendants):      Record,    pages 
13,382,  13,387. 
O'Connell    (witness   for  defendants):      Record,   page 

9,523. 
"(2)  The  replacement  of  particular  units  (other 
than  units  which  are  replaced  as  'repairs')  is  not  caused 
by  age,  wear  and  tear,  rust  or  rot,  but  by  inadequacy, 
or  by  the  appearance  of  new  types  of  apparatus.  The 
installation  of  apparatus  of  greater  capacity  results  in 
economies  in  the  cost  per  unit  of  service.  The  installa- 
tion of  new  types  of  apparatus  is  brought  about  be- 
cause the>r  are  more  economical. 

"(3)  There  is  no  basis  on  which  to  estimate  the 
time  at  which  apparatus  will  be  replaced  because  of 


52 


rates  fixed  by  the  Commission.  There  was  avail- 
able no  detailed  appraisal  of  the  railroad  prop- 
erties, and  the  carriers  submitted  as  a  basis  "the 
book  figures  for  investment  in  road  and  equip- 
ment, improvements  on  leased  railway  property, 
materials  and  supplies  and  government  allocated 
equipment,  hereinafter  referred  to  as  the  book 
costs"  (page  227). 

The  Interstate  Commerce  Commission  pointed 
out  that 

"The  carriers  recognize  the  infirmities 
inherent  in  the  investment  accounts  as  car- 
ried upon  the  books  of  the  carriers,  as  a 
measure  of  the  value  of  the  respective  prop- 
erties taken  separately.' ' 

The  aggregate  amount  carried  as  book  costs  of 
road  and  equipment  was  stated  to  be  $20,040,- 
572,611  (page  228). 

The  Commission  found  that 

"the  value  of  the  steam-railway  property  of 
the  carriers  subject  to  the  act  held  for  and 
used  in  the  service  of  transportation  is,  for 
the  purposes  of  this  particular  case," 

approximately  $18,900,000,000  {Re  Increased 
Freight  Rates,  1920,  58  I.  C.  C,  220,  229). 

The  exact  basis  on  which  the  Commission  re- 
duced the  aggregate  book  investment  from 
$20,040,572,611  to  $18,900,000,000  was  not  dis- 
closed in  the  published  opinion,  and  has  not  since 
been  made  public;  but  it  has  seemed  to  us  to  be 
obvious  that  the  Interstate  Commerce  Commis- 
sion took  no  account  whatever  of  "expired  life" 


inadequacy  or  obsolescence,  until  such  replacement  u 
imminent. 

(See  Office  Decision  1001,  Bureau  of  Internal  Rev- 
enue, page  21  of  Bulletin  35,  1921.)" 


53 


or  "accrued  theoretical  depreciation* '  in  arriving 
at  such  an  investment  figure  as  representing  a 
minimum  value  of  the  property  for  the  purpose  of 
granting  emergency  relief.  Had  any  such  deduc- 
tion been  made,  the  valuation  would  have  been 
placed  at  between  thirteen  and  fifteen  billion  dol- 
lars instead  of  at  $18,900,000,000,  which  was  but 
five  per  cent,  less  than  the  value  claimed  by  the 
carriers. 


The  Knoxville  Water  Company  Case  In  1909 

The  Knoxville  Water  Company  case  (212  U.  S., 
1)  is  sometimes  urged  as  authority  supporting 
the  view  of  the  ultra-depreciationists.  In  that 
case,  decided  in  1909,  the  Supreme  Court  said: 

"  A  water  plant,  with  all  its  additions,  be- 
gins to  depreciate  in  value  from  the  moment 
of  its  use.  Before  coming  to  the  question  of 
profit  at  all  the  company  is  entitled  to  earn 
a  sufficient  sum  annually  to  provide  not  only 
for  current  repairs  but  for  making  good  the 
depreciation  and  replacing  the  parts,  of  the 
property  when  they  come  to  the  end  of  their 
life.  The  company  is  not  bound  to  see  its 
property  gradually  waste  without  making 
provision  out  of  earnings  for  its  replace- 
ment. It  is  entitled  to  see  that  from  earn- 
ings the  value  of  the  property  invested  is 
kept  unimpaired,  so  that  at  the  end  of  any 
given  term  of  years  the  original  investment 
remains  as  it  was  at  the  beginning.  It  is 
not  only  the  right  of  the  company  to  make 
such  a  provision,  but  it  is  its  duty  to  its 
bond  and  stockholders,  and,  in  the  case  of 
a  public  service  corporation,  at  least,  its 
plain  duty  to  the  public.  //  a  different 
course  were  pursued  the  only  method  of 
providing  for  replacement  of  property 
which  has  ceased  to  be  useful  would  be  by 


54 


the  investment  of  new  capital  and  the  issue 
of  new  bonds  or  stocks.  This  course  would 
lead  to  a  constantly  increasing  variance  be- 
tween present  value  and  bond  and  stock 
capitalization — a  tendency  which  would  in- 
evitably lead  to  disaster  either  to  the  stock- 
holders or  to  the  public,  or  both." 

The  foregoing  does  not  seem  to  be  of  necessity 
at  variance  with  the  views  above  expressed,  al- 
though its  phrasing  was  not  as  exact  as  present- 
day  utility  experience  would  desire.  The  property 
of  a  utility  begins  to  experience  the  effects  of  use, 
as  soon  as  it  goes  into  use.  The  Court  is  dis- 
cussing the  question  of  rates  rather  than  of  valua- 
tion. It  says  that  the  utility  company  is  entitled 
to  earn  annually  a  sum  sufficient  to  provide,  not 
only  for  repairs,  but  also  for  "replacing  the  parts 
of  the  property"  when  they  are  no'  longer  suscep- 
tible of  use  and  have  to  be  replaced.  The  current 
rate  must  bear  the  current  cost  of  replacement 
as  well  as  repair,  as  the  need  arises.  The  Court 
was  declaring  a  principle,  rather  than  prescribing 
a  method.  In  other  words,  there  should,  of  course, 
be  at  all  times  included  in  the  operating  expenses 
of  a  railroad  or  other  public  utility  a  sufficient 
amount  to  provide  for  the  replacement  and  re- 
newal of  property  as  the  need  arises.  The  Court 
referred  to  "making  good  depreciation"  synony- 
mously with  "replacing  the  parts  of  the  property 
when  they  come  to  the  end  of  their  life."  This 
does  not  mean  that  a  reserve  for  "accrued  depre- 
ciation" based  on  theoretical  age  must  be  pro- 
vided, if  provision  is  made  for  meeting  all  with- 
drawals and  replacements  of  property  when  and 
as  the  need  arises.  If  proper  provision  is  made 
in  operating  expenses  for  current  replacements, 
and  the  property  is  kept  in  a  high  state  of  repair 


55 


and  efficiency,  as  railroad  property  is  required  to 
be  maintained,  both  as  the  result  of  legal  require- 
ment and  the  exigencies  of  operation,  the  invest- 
ment remains  unimpaired  and  subject  to  no  deduc- 
tion, and  no  "reserve"  need  be  set  up  to  create  a 
pretext  for  a  reduction. 

The  Minnesota  Rate  Case 

In  the  Minnesota  Rate  Case  (230  U.  S.,  352), 
the  Master  had  made  no  deduction  for  so-called 
" depreciation,' '  holding  that  while  as  to  certain 
classes  of  carrier  property  there  had  been  depre- 
ciation in  fact,  yet  it  was  more  than  offset  by  the 
appreciation ;  that  the  roadbed  was  constantly  in- 
creasing in  value  through  having  become  solidified 
and  adjusted  to  surface  drainage,  et  cetera.  The 
Supreme  Court  declined  to  approve  this  disposi- 
tion of  the  Master,  pointing  out  that  he  had  also 
allowed  a  gross  sum  separately  for  adaptation  and 
solidification  of  the  roadbed.  At  page  457,  Mr. 
Justice  Hughes  said: 

"It  is  also  to  be  noted  that  the  deprecia- 
tion in  question  is  not  that  which  has  been 
overcome  by  repairs  or  replacements,  but  is 
the  actual  existing  depreciation  in  the  plant 
as  compared  with  the  new  one.  It  would 
seem  to  be  inevitable  that  in  many  parts  of 
the  plant  there  should  be  such  depreciation, 
for  example,  old  structures  and  equipment 
remaining  on  hand.  And  when  an  estimate 
of  value  is  made  upon  the  basis  of  repro- 
duction new,  the  extent  of  existing  deprecia- 
tion should  be  shown  and  deducted.  •  •  • 
And  when  particular  physical  items  are 
estimated  as  worth  so  much  new,  if  in  fact 
they  be  depreciated,  this  amount  should  be 
found  and  allowed  for.  If  this  is  not  done 
the  physical  valuation  is  manifestly  incom- 
plete, and  it  must  be  regarded  as  incom- 


56 


plete  in  this  case.    Knoxville  vs.  Knoxville 
Water  Co.,  212  U.  S.  1,  10." 

There  can  be  little  doubt  as  to  the  kind  of  de- 
preciation the  Supreme  Court  was  discussing  in 
the  Minnesota  Rate  Case.  It  was  actual  deteriora- 
tion, represented  by  old  and  useless  buildings  and 
equipment  remaining  in  existence  and  retained  in 
the  capital  account,  but  no  longer  used  and  of  no 
utility,  not  equipment  and  buildings  actually 
rendering  service  as  economically  and  efficiently 
as  when  new. 

Furthermore  this  opinion,  with  its  qualification 
that  if  "existing"  (not  theoretical)  depreciation 
"be  found"  in  respect  of  "particular  physical 
items,"  not  the  property  as  a  whole  (in  other 
words,  that  only  "if  in  fact  they  be  depreciated" 
may  an  allowance  be  made),  completely  negatives 
the  assumption  of  "theoretical  depreciationists" 
that,  regardless  of  the  condition  of  the  property 
and  of  the  fact  that  its  capacity  for  service  is  Tin- 
impaired,  every  unit  must  nevertheless  be  re- 
garded as  having  suffered  an  average  diminution 
in  value  of  from  20  to  40  per  cent. 

In  Lincoln  Gas  Co.  vs.  Lincoln  (223  U.  S.,  349, 
363),  decided  two  years  after  the  Knoxville  case, 
which  is  supposed  by  some  to  have  settled  the 
whole  subject,  this  Court  nevertheless  said : 

"The  question  as  to  what  sum,  if  any, 
upon  the  facts  of  this  case,  should  be  an- 
nually deducted  from  the  net  income  as  a 
permanent  maintenance  or  replacement 
fund  is  novel,  and  presents  a  grave 
problem." 


57 
Comments  on  the  Knoxville  Case 

The  observations  of  Mr.  Justice  Moody  in  the 
Knoxville  case  have  recently  been  discussed,  from 
what  may  be  regarded  as  an  executive  and  ac- 
counting point  of  view,  rather  than  that  of  legal 
theory,  in  a  letter  sent  to  one  of  the  members  of 
the  Interstate  Commerce  Commission  by  one  of 
the  authors  of  this  memorandum  (Mr.  Carter) 
under  date  of  December  7,  1920,  and  that  com- 
munication is  here  quoted  from  in  lieu  of  a  restate- 
ment of  the  subject-matter  thereof.  After  making 
the  quotation  from  the  Knoxville  case  set  out  on 
pages  53  and  54  hereof,  ante,  the  letter  to  the 
Commissioner  continued : 

"Writing  as  a  layman,  it  does  not  seem 
to  me  that  this  expression  of  view  by  Judge 
Moody  in  his  opinion  in  the  Knoxville 
Water  Company  case  in  1909  is  necessarily 
to  be  construed  as  'the  holding  of  the 
Supreme  Court'  in  this  regard,  but  rather 
as  'dicta'  which  carries  no  finding  of  fact 
or  force  of  precedent. 

"It  is  a  question  whether  in  the  discus- 
sion of  this  subject  Judge  Moody  was  not 
departing  from  the  field  of  law  and  fact  and 
entering  that  of  theory  and  speculation  and 
directing  his  attention  to  questions  of 
economics  and  finance,  regarding  which,  at 
that  time,  there  was  sharp  disagreement  be- 
tween such  students  of  these  subjects  as 
had  ventured  to  express  an  opinion  thereon. 
Or  whether  Judge  Moody  did  not  go  even 
further  than  this  and  assume  a  familiar 
knowledge  of  the  effect  upon  physical  prop- 
erty of  its  employment  in  the  public  service, 
a  phase  of  the  subject  requiring  more  or 
less  technical  engineering  knowledge  which, 
it  must  be  assumed,  if  the  Court  concluded, 
as  is  alleged,  that  such  property  gradually 
wastes,  the  Court  did  not  possess. 


58 


"Must  it  be  assumed  that  the  Court  fell 
into  the  error  of  accepting  as  sound  theories 
of  depreciation  which  had  nothing  to  com- 
mend them  but  their  plausibility  and  which 
have  long  since  been  rejected  by  all  sound 
thinkers  1  And  if  so,  would  it  not  be  reason- 
able to  subject  the  remarks  of  the  Court  to 
the  closest  scrutiny  and  analysis  as  to  their 
meaning,  in  order  to  determine  whether 
they  are  really  susceptible  of  the  kind  of 
interpretation  which  some  students  of  the 
subject  are  disposed  to  place  upon  them? 

4 'It  may  be  noted,  for  example,  that 
Judge  Moody's  language  has  been  availed 
of  by  professional  depredationists  as  sus- 
taining them  in  the  application  of  theories 
of  accrued  depreciation  designed  to  impair, 
by  purely  artificial  means,  the  investment 
of  public  utilities  in  plant  and  equipment 
devoted  to  the  public  service.  In  fact,  it  is 
the  only  language  appearing  in  any  deci- 
sion of  the  United  States  Supreme  Court 
which  even  appears  to  sustain  these  de- 
structive theories. 

"There  is  not  the  slightest  indication  that 
in  Judge  Moody's  mind  there  was  any 
thought  of  the  impairment  of  the  invest- 
ment of  utilities  in  their  properties  through 
the  application  of  depreciation  theories. 
On  the  other  hand,  the  language  of  the 
Court  in  the  paragraph  quoted  plainly  dis- 
closes the  intent  of  the  Court  to  indicate  the 
rights  and  privileges  of  utilities  to  main- 
tain their  properties  and  their  investment 
intact.  In  the  first  sentence,  for  example, 
the  words  'the  company  is  entitled'  are 
used;  in  the  second  sentence  appear  the 
words  'The  company  is  not  bound  to  see  its 
property  gradually  waste,  in  the  third 
sentence  the  words  'It  (the  company)  is  en- 
titled to  see  that  from  earnings,  etc,  etc.,' 
are  used,  and  in  the  fourth  and  last  sentence 
in  the  paragraph  are  found  the  words  'The 


59 


right  of  the  company'  and  'Its  (the  com- 
pany's) duty  to  its  bond  and  stockholders, 
etc.;'  this  sentence  also  indicating  that  in 
the  Court's  opinion,  making  provision  for 
the  maintenance  of  the  property  by  re- 
newals and  replacements  is  the  public  serv- 
ice corporation's  plain  duty  to  the  public. 

"From  the  writer's  point  of  view,  the 
thought  which  was  in  Justice  Moody's  mind 
and  which  he  sought  to  express  in  the  form 
of  a  rule  of  procedure  was,  in  substance, 
that  the  maintenance  of  plant  and  equip- 
ment by  renewals  and  replacements  was  a 
proper  charge  against  earnings  and  that 
the  earnings  should  be  a4equate  for  this 
purpose.  In  other  words,  that  the  cost  of 
such  maintenance  should  not  be  capitalized. 
All  of  which  is  perfectly  sound.  In  fact, 
it  is  so  self  evident  as  to  lead  one  to  in- 
quire as  to  the  reason  for  its  enunciation. 
The  answer  is  found  in  the  fact  that  in  the 
Knoxville  Water  Company  case  the  Master 
included  in  the  assets  of  the  company — in 
other  words,  in  the  rate  base  upon  which 
the  rate  of  return  was  computed — certain 
plant  and  equipment  that  had  been  super- 
seded by  other  plant  and  equipment  and 
had  been  definitely  withdrawn  from  service. 
In  the  Court's  opinion  this  inclusion  was 
improper  on  the  theory  that  the  discarded 
plant  and  equipment  should  have  been 
charged  against  prior  earnings  and  not  con- 
tinued in  capital  account.  The  record  does 
not  disclose  (1)  whether  the  earnings  had 
been  theretofore  adequate  to  enable  the 
writing  off  of  the  loss  due  to  the  withdrawal 
in  question;  (2)  whether,  if  they  were  in- 
adequate, the  company  had  the  right 
arbitrarily  and  of  its  own  motion  to  in- 
crease its  rates  and  make  them  adequate. 
If  the  answer  to  both  is  in  the  negative 
then  an  obvious  error  was  committed  be- 
cause the  right  to  charge  the  loss  against 
the     earnings    continued     and    provision 


60 


should  have  been  made  therefor  in  the  rate 
under  review,  which  would  require  a  slight- 
ly higher  rate  during  the  period  of  amorti- 
zation than  would  be  necessary  to  pay 
merely  a  return  on  the  unamortized  invest- 
ment. If  it  was  the  Court's  intention  to 
establish  a  rule  that  the  loss  due  to  renewal 
and  replacement  of  property  may  in  no 
event  be  charged  against  earnings  accru- 
ing after  the  fact,  then  such  rule  has 
definitely  been  set  aside  by  the  United 
States  Supreme  Court  in  the  Kansas  City 
Southern  case. 

"It  has  come  to  be  generally  recognized 
that  a  very  large  percentage  of  the  cost  of 
supersessional  operations,  commonly  al- 
luded to  as  'renewals  and  replacements, '  is 
due  to  inadequacy  or  to  advancement  in  the 
science  of  rendering  public  utility  service. 
Some  of  the  best  informed  engineers  attri- 
bute from  90  to  %  per  cent,  of  the  cost  of 
so-called  renewals  and  replacements  to 
these  causes  and  from  five  to  ten  per  cent, 
to  wear  and  tear.  This  being  the  case  it  is 
manifest  that  such  cost  is  chargeable 
against  current  or  subsequent  earnings  and 
not  at  all  to  prior  earnings.  As  a  matter  of 
fact  it  is  almost  universally  provided  for 
out  of  current  earnings.  The  most  recent 
system  of  accounting  formulated  for  public 
utilities  (*)  provides  not  only  that  the  cost 
of  renewals  and  replacements  shall  be 
charged  against  current  earning  but  that  in 
case  the  amount  involved  exceeds  the  cur- 
rent provision  therefor  together  with  such 
balance  as  may  appear  to  the  credit  of  the 
renewal  account  it  may  be  carried  in  a  capi- 
tal suspense  account  pending  its  amortiza- 


(*)  Uniform  System  of  Accounts  for  Gas  and  Electric 
Companies,  recommended  to  the  regulatory  commissions  of 
the  various  States  by  the  National  Association  of  State  Rail- 
way and  Public  Utility  Commissioners  at  its  Annual  Con- 
vention in  Washington,  D.  C,  November  9-12th,  1920. 


61 


tion  through  the  annual  provision  for  this 
purpose. 

"In  this  connection  the  report  of  the 
Special  Master  in  the  New  York  and  Queens 
Gas  Company  case,*  a  copy  of  which  is  en- 
closed, contains  a  discussion  of  the  subject 
and  of  the  testimony  of  witnesses  in  the 
case  who  make  the  exploitation  of  theories 
of  so-called  *  accrued  depreciation'  a  matter 
of  their  bread  and  butter. 

"The  fact  that  the  greater  part  of  the 
plant  and  equipment  of  a  utility  has  no  as- 
certainable life  and  that  if  kept  in  repair  it 
can  be  operated  as  efficiently  as  when  it  was 
installed  until  the  end  of  time,  unless  for 
purely  economic  reasons  it  is  displaced  by 
other  plant  and  equipment,  leads  to  the  con- 
clusion that  if  Judge  Moody's  conclusions 
were  based  upon  the  assumption  that  such 
property  had  a  definite  life  which  was 
terminated  by  wear  and  tear  and  that  in  the 
meantime  it  was  gradually  wasting,  he  was 
palpably  and  obviously  in  error.  In  this  as 
in  all  other  debatable  subjects  theory  must, 
in  the  final  analysis,  yield  to  fact. 

"It  is  not  necessary,  however,  to  ascribe 
error  to  the  Court  if  the  language  used  may 
be  shown  not  to  justify  the  extreme  in- 
terpretation put  upon  it  by  professional 
depreciationists. 

"The  first  sentence  in  the  quoted  para- 
graph reads  as  follows: 

'Before  coming  to  the  question  of  profit 
at  all  the  company  is  entitled  to  earn  a 
sufficient  sum  annually  to  provide  not 
only  for  current  repairs  but  for  making 
good  the  depreciation  and  replacing  the 
parts  of  the  property  when  they  come  to 
the  end  of  their  life.' 


♦Quoted  on  pages  26  to  31  hereof,  ante. 


62 


"If  there  is  any  doubt  that  what  is  meant 
by  the  last  half  of  the  sentence  is  that  the 
company  is  entitled  to  earn  a  sufficient  sum 
annually  for  making  good  depreciation  by 
replacing  the  parts  of  the  property  when 
they  are  withdrawn  from  service,  then  Con- 
gress has  settled  the  question  in  the  Water 
Power  Bill  by  providing  for  a  depreciation 
reserve  and  denning  very  definitely  what  it 
is  for,  viz.,  the  renewal  and  replacement  of 
plant  and  equipment.  The  same  bill  also 
plainly  indicates  that  by  such  renewal  and 
replacement  the  investment  is  kept  intact 
and  unimpaired.' ' 

"The  second  sentence  reads  as  follows: 

'The  Company  is  not  bound  to  see  its 
property  gradually  waste,  without  mak- 
ing provision  out  of  earnings  for  its  re- 
placement. ' 

"In  the  light  of  the  facts  before  the 
Court  in  this  case  it  may  be  assumed  that 
the  Court  had  reference  to  the  practice  ap- 
parently prevailing  in  that  company  of  con- 
tinuing to  carry,  in  capital  account,  prop- 
erty which  had  been  withdrawn  from  serv- 
ice and  discarded,  making  no  provision 
either  at  the  time  or  subsequently  for  the 
amortization  out  of  earnings  of  the  invest- 
ment therein,  which  practice  would  repre- 
sent a  wasting  of  assets  and  an  impairment 
of  the  investment  as  measured  by  the  prop- 
erty remaining  in  service,  and  that  the 
thought  in  the  mind  of  the  Court  was  that 
the  cost  of  property  displaced  and  with- 
drawn from  service  should  be  charged 
against  the  earnings. 

"The  third  sentence  reads: 

'It  is  entitled  to  see  that  from  earn- 
ings the  value  of  the  property  invested 
is  kept  unimpaired,  so  that  at  the  end  of 
any  given  term  of  years  the  original  in- 


63 


vestment  remains  as  it  was  at  the  begin- 
ning.' 

"If  a  ntility  has  been  permitted  to  earn 
a  sufficient  sum  annually  to  enable  it  to 
charge  all  property  withdrawn  from  service 
against  earnings  and  had  so  charged  off  all 
displaced  property  and  has  maintained  the 
rest  of  its  plant  and  equipment  ;i  ~^od 
operating  condition,  so  that  at  the  end  of 
any  terms  of  years  its  capacity  for  render- 
ing service  remains  unimpaired,  the  original 
investment  in  the  plant  still  in  service  re- 
mains what  it  was  at  the  beginning.  Prof. 
Laughlin  has  well  referred  to  the  invest- 
ment as  a  stream  of  capital.  As  fast  as 
water  from  the  stream  runs  over  the  mill- 
wheel,  it  is  replaced  by  new  water.  The 
value  of  the  water-power  is  not  decreased 
by  the  water  that  runs  away. 

"Judge  Learned  Hand,  in  the  Consoli- 
dated Gas  Company  case  last  August, 
found  as  follows,  in  this  regard : 

*  *  *  *  if  in  fact  the  capacity  (of  the 
plant)  has  remained  the  same,  deprecia- 
tion should  not  be  a  function  of  the  "rate 
base"  at  all.  In  such  a  case  the  inquiry 
as  to  depreciation  should  be  confined  to 
changes  in  "price  levels". ' 

"Thus  interpreted  Justice  Moody's  opin- 
ion conforms  not  only  to  sound  theories  of 
economics  and  finance,  but  to  the  facts  re- 
garding the  operation  and  maintenance  of 
the  plants  and  equipment  of  public  utili- 
ties. 

"Shrinkage  in  value  may  not  be  attrib- 
uted to  the  mere  incidence  of  use  where  the 
article  used  does  not  deteriorate  from  use. 
Therefore,  the  word  'depreciation'  applied 
to  property  which  does  not  deteriorate  from 
use,  must  have  the  meaning  of  'a  shrinkage 
in  value'  due  to  a  decrease  in  the  price 
level.     Similarly  the  word  'appreciation' 


64 


applied  to  property  which  does  not  improve 
from  use  must  have  the  meaning  of  'an  ex- 
pansion in  value'  due  to  an  increase  in  the 
price  level. 

"The  proposition  that  an  investment  in 
property,  which  does  not  deteriorate  from 
use,  begins  to  'shrink'  the  moment  it  is 
made,  notwithstanding  the  fact  that  the 
price  level  remains  unchanged,  cannot  be 
sustained  for  a  moment.  It  is  not  conceiv- 
able that  Justice  Moody  would  have  made 
such  a  pronouncement  as  this;  and  yet, 
shorn  of  all  verbiage,  this  is  just  the  inter- 
pretation which  some  theorists  seek  to 
place  upon  his  utterances. 

"The  kind  of  shrinkage  which  Justice 
Moody  had  in  mind  is  that  which  would 
result  from  failure  to  charge  the  cost  of 
displaced  property  against  earnings  and 
from  capitalizing  the  expenditures  involved 
in  supersessional  transactions  thus  destroy- 
ing the  parity  between  outstanding  stock 
and  bonds  and  property  in  actual  service, 
the  former  exceeding  the  latter,  thus  pro- 
ducing a  shrinkage  in  the  property  in  serv- 
ice as  compared  with  the  capitalization. 
That  this  was  really  all  that  he  had  in 
mind  would  seem  to  be  established  beyond 
controversy  by  his  remarks  immediately 
following  those  heretofore  quoted : 

'If  a  different  course  were  pursued  the 
only  method  of  providing  for  replace- 
ment of  property  which  has  ceased  to  be 
useful  would  be  by  the  investment  of  new 
capital  and  the  issue  of  new  bonds  or 
stocks.  This  course  would  lead  to  a  con- 
stantly increasing  variance  between  pres- 
ent value  and  bond  and  stock  capitaliza- 
tion— a  tendency  which  would  inevitably 
lead  to  disaster  either  to  the  stockholders 
or  to  the  public,  or  both.'  " 


65 
The  Kansas  City  Southern  Case 

It  may  further  be  pointed  out  that  if,  as  is  often 
urged,  the  Supreme  Court  intended  in  the  Knox- 
ville  case  to  hold  that  the  cost  of  superseded  prop- 
erty should  not  be  amortized   from   present   or 
future    earnings,    its   decision   in   Kansas   City 
Southern'  By.  Co.  vs.  U.  8.  (231  U.  S.  423;  quoted 
from  on  pages  98  to  100,  post),  must  be  regarded 
as  an  overruling  precedent.    The  major  part  of  the 
culminated  depreciation  involved  in  the  Knoxville 
case  arose  from  the  abandonment  of  a  water  sta- 
tion  which   had    cost    a   predecessor   company 
$52,000.    Its  withdrawal  from  service  was  attrib- 
uted to  the  fact  that  it  was  a  duplication  of  plant 
facilities,  and  its  use  by  the  present  company  was 
no  longer  economical  or  necessary.    The  position 
of  the  company  before  the  Circuit  Court  was  that 
the  amount  of  "culminated  depreciation"  should 
not  be  deducted  from  the  "rate  base"  unless  and 
until  the  same  had  been  amortized  and  provided 
for  through  the  operating  expense  accounts  (Print 
202;  13th  Exception,   Print  191).     The   Circuit 
Court  sustained  this  contention.    The  Supreme 
Court  deducted  $50,000  for  "depreciation"  from 
the  figures  representing  "reproduction  cost  new," 
but  omitted  to  add  anything  to  the  expense  ac- 
counts for  the  amortization  of  the  sum  deducted. 
In  the  Kansas  City  Southern  case,  nearly  five 
years  later,  the  Supreme  Court  sustained  a  rule 
of  the  Interstate  Commerce  Commission  provid- 
ing for  the  amortization  by  way  of  charge  to 
future  operating  expenses  of  the  cost  of  portions 
of  a  railway  division  withdrawn  from  service  be- 
cause of  the  construction  of  a  new  line  with  lower 
grades  and  increased  capacity,  holding  that  the 
cost  of  property  thus  withdrawn  from  service 
should  not  remain  in  the  investment  accounts  and 


66 


that  "abandonments  occasioned  by  changes  of 
this  character  are  therefore  chargeable  to  future 
earnings. ' ' 

The  First  Consolidated  Gas  Company  Rate  Case 

The  case  of  Willcox  vs.  Consolidated  Gas  Com- 
pany (212  U.  S.,  19),  which  was  decided  on  Jan- 
uary 4,  1909,  the  same  day  the  case  of  the 
City  of  Knoxville  vs.  Knoxville  Water  Co.  was 
decided,  but  in  which  the  opinion  was  filed  on  Jan- 
uary 12,  1909,  is  sometimes  cited  as  a  companion 
case  to  the  Knoxville  case  and  in  support  of  the 
contention  that  "theoretical  accrued  deprecia- 
tion*'  should  be  deducted  from  the  reproduction 
cost.* 

Any  claim  that  the  decision  in  the  first  Consoli- 
dated Gas  Company  case  sustains  such  a  theory 
is  due  to  a  lack  of  familiarity  with  the  facts  in 
that  case,  and  with  what  the  Court  did  in  fact  find 
and  decide.  The  learned  Master  in  that  case  flatly 
rejected  the  claims  of  fact  on  which  "theoretical 
depreciation"  was  advanced  by  the  defendants' 
witness  Marks,  for  the  first  time  in  any  rate  case 
in  court  (Master's  Keport,  pages  35-37) ;  Judge 
Hough,  sitting  in  the  United  States  Circuit  Court, 
approved  the  Master's  finding  (157  Fed.  Rep., 
849,  856) ;  and  the  United  States  Supreme  Court 
made  no  modification  of  the  finding  of  the  lower 
Court  in  this  respect  (212  U.  S.,  19,  52). 

The  facts  in  the  first  Consolidated  Gas  Com- 
pany case,  as  disclosed  in  the  record,  are  in  brief 
as  follows:  The  complainant  company  called  to 
the  stand  Mr.  Frederick  J.  Mayer,  who  had  been 
a  practicing  mechanical  engineer  for  thirty-four 


Consolidated  Gas  Company  rate  suit,  decided  March  6,  1922, 
♦For    the   decision    of   the    Supreme    Court    in    the    second 
see  foot-note  on  page  32,  ante. 


67 


years,  and  for  the  preceding  twenty-three  years 
had  been  connected  with  the  firm  of  Bartlett-Hay- 
ward  Company,  the  largest  manufacturers  of 
gas  holders  and  apparatus  in  the  country.  Mr. 
Mayer  testified  to  a  value  of  the  plant,  consisting 
of  buildings,  apparatus,  holders  and  general  con- 
nections at  the  stations,  of  $15,532,489,  after  de- 
ducting the  sum  of  $604,988, 

"for,  depreciation  based  on  an  examination 
of  each  individual  item  upon  which  it  was 
computed.  Such  deduction  represented  his 
estimate  of  what  would  be  required  to  place 
the  plant  in  every  respect  in  condition  as 
good  as  new,  and  amounted  in  the  aggre- 
gate to  $604,988."  (Master's  Keport, 
pages  29  to  30,  35). 

A  purported  valuation  was  also  put  in  by  Mr. 
Henry  H.  Edgerton,  who  estimated  the  value  of 
the  "plant"  at  $10,023,057.25;  and  another  pur- 
ported valuation  was  put  in  by  Mr.  William  D. 
Marks,  also  called  in  behalf  of  the  defendants, 
who  estimated  the  value  at  $9,348,692  (Master's 
Report,  page  29).  Mr.  Edgerton  and  Mr.  Marks, 
according  to  the  Master  (Report,  page  31) : 

"showed  no  especial  qualifications  to  tes- 
tify as  experts  on  this  branch  of  the  case. 
Neither  Mr.  Marks  nor  Mr.  Edgerton  had 
recent  experience  in  the  construction  of  gas 
giants  in  large  cities  or  showed  familiar- 
ity with  existing  metropolitan  conditidns. 
The  former,  some  30  years  ago,  was  con- 
nected with  the  construction  of  a  plant  in 
St.  Louis,  but  his  practical  experience  in 
recent  years  has  been  limited  to  small 
towns  in  North  Carolina.  He  has  never 
conducted  building  operations  or  installed 
manufacturing  apparatus  in  New  York 
City.  This  is  the  case  likewise  with  Mr. 
Edgerton.  His  chief  connection  with  prac- 
tical gas  manufacturing,  aside  from  a  small 


68 


plant  in  Connecticut,  appears  to  have  been 
over  30  years  ago.  Neither  of  these  gentle- 
men made  a  careful  detailed  examination 
of  the  plants,  and  each  frankly  stated  that 
the  time  at  his  disposal  was  entirely  inade- 
quate for  the  preparation  of  an  accurate 
appraisal  of  values." 

Mr.  Marks,  the  defendant's  witness,  had  made 
a  deduction  for  "theoretical  depreciation  of  the 
proposed  life  of  the  plant,"  and  this  deduction 
was  completely  rejected  by  the  Master,  as  appears 
from  the  following  portion  of  his  report  (pages 
35  to  37) : 

"Having  thus  obtained  his  total  cost,  Mr. 
Mayer  made  deductions  for  depreciations 
based  on  an  examination  of  each  individual 
item  upon  which  it  was  computed.  Such 
deductions  represented  his  estimate  of 
what  would  be  required  to  place  the  plant 
in  every  respect  in  condition  as  good  as 
new,  and  amounted  in  the  aggregate  to 
$604,988. 

"The  examination  made  by  Mr.  Edger- 
ton  was  of  such  a  cursory  nature  that  his 
figures  for  depreciation  were  necessarily 
made  less  carefully.  In  one  case,  for  in- 
stance, he  ascribed  the  same  depreciation 
of  10  per  cent,  to  new  apparatus  installed 
in  1904-5,  as  to  old  apparatus  installed  15 
or  16  years  earlier. 

"Mr.  Marks  did  not  particularly  regard 
the  extent  of  depreciation  actually  existing, 
but  assumed  a  theoretical  deterioration  of 
the  supposed  life  of  the  plant. 

"He  testified: 

"  'Depreciation  results  from  several 
causes.  The  motet  ordinary  one  is  decay 
or  wear  and  tear,  as  observed.  There  is 
another  factor  which  is  inadequacy,  ow- 
ing to  the  increase  of  the  business.  There 


69 


is  also  another  cause  of  depreciation, 
obsolescence,  which  is  due  to  the  changes 
in  the  arts  and  in  the  methods  and  in 
the  general  growth  of  scientific  knowl- 
edge; if  a  works  built  at  a  certain  period 
is  kept  in  perfect  repair,  meaning  by 
that,  always  restored  to  their  original 
condition,  and  in  good  working  condi- 
tion, there  remains,  assuming  that,  a  de- 
preciation due  to  both  obsolescence  and 
to  inadequacy. ' 

"In  this  view  he  made  estimates  on  the 
theory  of  the  cost  of  final  replacement  to 
cover  such  inadequacy  or  obsolescence 
ranging  from  25  per  cent,  to  60  per  cent, 
and  based  on  a  supposed  life  of  120  years 
for  the  plant.  The  discrepancy  between 
his  valuations  and  those  of  Mr.  Mayer  is 
largely  due  to  their  different  methods  of 
estimating  depreciation.    He  said: 

"  'Mr.  Mayer  does  not  differ  largely 
from  my  own  figures  of  structural  cost. 
You  may  say  for  all  ordinary  purposes 
they  coincide,  with  the  exception  of  the 
gas  holders,  and  even  there  they  do  not 
differ  largely.  It  is  the  question  of  de- 
preciation entirely.' 

"As  will  hereafter  appear,  it  is  proper 
in  the  administration  of  a  manufacturing 
plant  to  take  depreciation  of  the  character 
above  described  into  account  and  provide 
against  it  by  setting  aside  a  reserve  fund 
from  current  earnings.  For  the  purpose  of 
determining  present  value,  however,  par- 
ticularly on  the  basis  of  cost  of  reproduc- 
tion, the  method  followed  by  Mr.  Marks 
does  not  commend  itself.  It  appears  from 
the  record  without  substantial  dispute,  that 
while  certain  of  the  plants  and  apparatus 
may  not  be  in  perfect  repair,  they  are,  as 
a  whole,  in  efficient  operating  condition,  and 
that  a  large  proportion  of  their  capacity  is 
represented  by  the  latest  pattern  of  water 


70 


gas  apparatus  installed  within  the  last  few 
years.    The  books  show  expenditures  since 
November,  1885: 
For  renewals  offsetting  depre- 
ciation by  loss  or  abandon- 
ment   $1,227,683.10 

For  repairs  to  buildings 1,275,749.03 

For  repairs  to  apparatus 4,865,362.51 

New  construction 3,904,937.31 

Total $11,273,731.95 

' '  The  fact  thus  being  that  the  plants  are 
in  good  order  and  operating  efficiently,  it 
does  not  appear  reasonable,  for  the  pur- 
poses of  this  case,  to  charge  them  with  a 
theoretical  deficiency  so  great  as,  if  actu- 
ally existing,  would  make  their  successful 
operation  a  practical  impossibility.  An  es- 
timate of  depreciation  like  those  of  Mr. 
Edgerton  and  Mr.  Mayer,  based  on  a  de- 
tailed examination  of  the  property  as  it 
stands  today,  affords  in  my  opinion  a  more 
fair  and  practical  method  to  be  followed,  in 
determining  its  value. 

"I  accordingly  find  and  report  the  value 
of  the  complainant's  plants  to  be  substan- 
tially in  accordance  with  the  estimate  of 
Mr.  Mayer,  a  summary  of  which  is  given 
below;  but  adopting,  for  purposes  of  con- 
venience and  to  allow  for  possible  over- 
valuations in  some  details,  the  round  fig- 
ure of  $15,500,000,  instead  of  $15,532,489, 
as  shown  by  the  appraisal." 

It  is  true  that  the  Master  made  a  deduction  for 
the  amount  representing  Mr.  Mayer's  estimate 
"of  what  would  be  required  to  place  the  plant  in 
every  respect  in  condition  as  good  as  new,"  but 
the  amount  was  arrived  at  by  the  actual  examina- 
tion of  the  plant  and  report  of  its  actual  condi- 
tion, and  not  by  any  theoretical  estimate  of  ex- 
pired age  based  upon  hypothetical  lives  attributed 
to  the  component  parts  of  the  plant  or  by  a  pro- 


71 


cess  of  averaging  which  is  altogether  baseless  and 
misleading. 

In  even  this  deduction,  we  believe  the  learned 
Master  was  in  error,  under  the  decisions  else- 
where cited.  The  amount  which  might  be  thus  ex- 
pended on  a  plant  which  is  in  good  repair  and 
operating  efficiency,  in  order  to  put  it  in  a  condi- 
tion substantially  as  good  as  new,  does  not  meas- 
ure an  impairment  of  the  investment  in  the  prop- 
erty and  should  not  be  deducted  from  such  in- 
vestment in  fixing  a  rate  or  testing  its  validity. 
The  condition  of  the  particular  units  of  plant  and 
equipment  on  which  such  a  computation  is  based 
is  only  temporary.  It  is  a  mere  incident  of  plant 
and  equipment  operation.  It  possesses  no  eco- 
nomic significance  whatever.  As  the  sum  com- 
puted will  be  paid  out  of  the  rate  collected  from 
ratepayers,  as  repairs  and  replacements  mature, 
it  may  be  described  as  an  "unmatured  obliga- 
tion "  of  the  ratepayers  to  reimburse  the  company, 
through  the  medium  of  the  rates  they  pay  for  the 
service  they  receive,  for  the  cost  of  the  mainte- 
nance and  upkeep  of  the  plant  and  equipment. 

The  Opinion  of  Judge  Hough  in  the  Circuit  Court 

When  the  report  of  the  Master  in  the  Consoli- 
dated Gas  case  came  before  Judge  Hough  in  the 
United  States  Circuit  Court,  he  completely  ap- 
proved the  Master's  finding  and  his  method  of  ar- 
riving at  the  value  in  this  respect  (Consolidated 
Gas  Co.  vs.  City  of  New  York,  157  Fed.  Rep.,  849, 
854,  855,  856),  saying: 

"In  every  instance  the  value  assigned 
in  the  report  is  what  it  would  cost  pres- 
ently to  reproduce  each  item  of  property, 
in  its  present  condition,  and  capable  of  giv- 
ing service  neither  better  nor  worse  than 
it  now  does7' 


72 


"I  think  the  method  of  valuation  applied 
by  the  report  to  land,  plant,  mains,  ser- 
vices and  meters  lawful." 

Except  in  respect  of  a  single  item,  the  valua- 
tion found  by  Judge  Hough  was  adopted  and  util- 
ized by  the  United  States  Supreme  Court,  with 
no  suggestion  at  all  that '  *  accrued  theoretical  de- 
preciation" should  be  deducted  from  value  new 
or  from  investment,  or  that  the  rate  should  be 
tested  on  a  basis  burdening  it  with  accruals  for 
"depreciation"  based  on  assumed  expiration  of 
life  expectancy. 

The  Decision  of  the  Arizona  District  Court  in  Bon- 
bright  vs.  Geary 

Reference  is  frequently  made  to  the  decision  of 
the  Special  Statutory  Court  convened  under  Sec- 
tion 266  of  the  Judicial  Code  of  the  United  States 
in  Bonbright  vs.  Geary  (210  Fed.  44),  as  sus- 
taining the  deduction  of  "accrued  theoretical  de- 
preciation." We  do  not  find  such  a  citation  to  be 
warranted.  That  decision  was  rendered  in  the 
United  States  District  Court  for  Arizona,  in  1913, 
by  Morrow,  Circuit  Judge,  and  Van  Fleet  and 
Sawtelle,  District  Judges.  The  rates  proceeded 
against  were  gas  and  electric  rates  prescribed  by 
the  Corporation  Commission  of  Arizona.  After 
quoting  (210  Fed.  52)  from  the  "uncontradicted 
statement"  of  the  expert  engineer  for  the  com- 
pany to  the  following  effect: 

"Condition  of  Property.  The  gas  and 
electric  plants  of  Pacific  Gas  &  Electric 
Company  are  in  good  and  efficient  con- 
dition. All  parts  of  the  electric  generating 
plant  are  modern,  up-to-date  installations, 
including  turbo-generators,  water-tube  boil- 
ers, condensers,  oil  and  lamp  black  burn- 
ing apparatus,  etc.    There  is  an  ample  wa- 


73 


ter  supply  obtained  from  wells.  The  new 
gas  generating  plant  is  a  modern,  up-to- 
date,  reversible  Lowe  water  gas  apparatus. 
Both  plants  are  housed  in  brick  buildings 
with  steel  truss  roofs  covered  with  fireproof 
material.  Neither  plant  could  be  improved 
upon  anywhere.  The  electric  distributing 
system  is  the  most  modern  type  for  distri- 
bution in  cities  of  this  character,  and  all 
the  lines,  transformers,  and  service  equip- 
ment are  of  the  latest,  most  improved  type. 
The  gas  distributing  system  includes  ample 
mains,  well  laid,  the  greater  portion  of 
which  have  been  installed  during  the  last 
three  years.  This  distributing  system  is  in 
the  best  possible  condition  and  of  the  most 
up-to-date  qualifications.  The  utility  equip- 
ment of  the  company  is  also  of  the  latest 
design,  including  automobile  trucks  and  the 
latest  office  labor-saving  devices." 

The  Court,  through  Morrow,  Circuit  Judge, 
said,  along  lines  sustaining  the  views  hereinbefore 
expressed  as  to  the  proper  interpretation  of  the 
Knoxville  case: 

"It  would  seem  that,  if  the  plant  is  in  the 
condition  set  forth  in  this  statement,  a 
deduction  of  49  per  cent,  from  its  original 
value  for  depreciation,  or  approximately 
that  percentage,  is  excessive;  but  to  what 
extent  it  is  excessive  we  do  not  now  deter- 
mine. We  call  attention  to  the  statement 
for  the  purpose  of  referring  to  the  fact  that 
the  plant  appears  to  have  been  kept  in 
repair  and  is  now  in  good  condition.  In 
the  Knoxville  case  the  Supreme  Court  com- 
mended this  method  of  preserving  the  in- 
tegrity of  a  public  service  plant.  *  •  • 

"This  brings  us  to  a  peculiar  feature  of 
this  case.  There  was  on  hand  in  the  treas- 
ury of  the  company  at  the  time  of  the  valua- 
tion of  the  plant  the  sum  of  $64,292.67, 
accumulated  for  the  purpose  of  meeting  the 


74 


expense  of  current  repairs  and  for  replac- 
ing such  parts  of  the  property  as  had  been 
worn  out  and  the  life  of  the  part  ended. 
The  fund  had  been  withheld  from  the  stock- 
holders that  it  might  be  used  in  preserving 
the  plant  in  good  condition  and  in  proper 
efficiency.  This  was  good  business  judg- 
ment on  the  part  of  the  officers  of  the  cor- 
poration and  must  be  approved.  Public 
service  corporations  are  to  be  encouraged 
in  maintaining  their  plants  in  a  proper  state 
of  efficiency.  We  are  of  the  opinion  that 
the  Corporation  Commission  was  in  error 
in  its  estimate  of  depreciation  of  this  plant, 
and  particularly  was  in  error  in  omitting 
this  reserve  fund  from  its  valuation  of  the 
plant." 

The  Cumberland  Telephone  &  Telegraph  Case 

The  decision  of  the  United  States  Circuit 
Court  in  Cumberland  Telephone  &  Telegraph  Co. 
vs.  City  of  Louisville  (157  Fed.  637,  650;  reversed 
212  U.  S.  414),  does  not  seem  to  warrant  the  fre- 
quent references  made  to  it  by  advocates  of  the 
"accrued  depreciation"  theory.    The  Court  said: 

"We  have  not  been  able,  from  anything 
said  by  the  Master,  to  see  what  his  reasons 
were  for  the  reduction  of  10  per  cent,  for 
depreciation,  as  shown  in  the  above  extract 
from  his  report,  particularly  as  the  large 
sums  shown  by  him  to  have  been  expended 
for  maintenance  and  reconstruction  had,  as 
he  tells  us,  put  the  plant  in  excellent  con- 
dition and  practically  equal  to  a  new  one, 
and  had  prevented  any  material  change  of 
its  value  during  the  20  months  the  case  was 
before  him.  If  we  eliminate  the  10  per  cent, 
reduction  made  by  the  Master  we  find  that 
his  estimate  of  the  value  of  the  plant  would 
be  $1,506,665.09,  which  would  be  $133.88  in 
excess  of  the   original  cost  of  the  plant, 


70 

which  he  found  to  have  been  $1,506,531.21. 
We  think  the  reduction  of  10  per  cent,  un- 
der the  circumstances,  was  in  large  measure 
an  arbitrary  reduction  in  the  sense  that  it 
was  without  an  adequate  basis  in  view  of 
the  large  expenditures  made  to  keep  the 
plant  up  to  the  standard." 

Oklahoma    and    Pennsylvania    Decisions    Sometimes 
Cited  as  Adverse  Authority 

Advocates  of  "accrued  theoretical  deprecia- 
tion "  often  cite  as  authority  in  their  behalf  the 
decision  in  Pioneer  Telephone  &  Telegraph  Co.  vs. 
Westenhaver  (29  Okla.  420)  (1911).  In  so  doing 
they  overlook  the  later  decision  in  Pioneer  Tele- 
phone &  Telegraph  Co.  vs.  State  of  Oklahoma  (167 
Pacific  995),  in  which  the  Supreme  Court  of  Okla- 
homa, in  1917,  ruled  that  there  should  be  no  de- 
duction for  depreciation  in  the  determination  of 
value.  In  that  case  certain  telephone  rates  fixed 
by  the  Corporation  Commission  were  in  contro- 
versy. There  were  the  usual  questions  of  the 
value  of  the  property,  costs  of  operation,  and 
margin  of  profit.  The  Corporation  Commission 
had  ruled  that  inasmuch  as  the  physical  plant  was 
kept  up  to  a  high  degree  of  efficiency  by  renewals 
and  replacements  paid  for  out  of  current  revenue, 
there  was  no  depreciation,  and  there  should  be  no 
allowance  for  a  reserve  fund.  The  Supreme  Court 
sustained  the  position  of  the  Commission,  saying : 

"Another  ground  for  complaint  is  based 
upon  the  claim  that  the  Corporation  Com- 
mission refused  to  allow  the  company  a  suf- 
ficient reserve  for  depreciation.  The  Com- 
mission held  that,  inasmuch  as  the  evidence 
showed  that  the  physical  plant  was  kept  up 
to  a  high  degree  of  efficiency  by  replace- 
ments paid  for  -out  of  current  revenue,  and 
that   any  deterioration   covered  by  obso- 


76 


lescence  would  not  affect  the  result  in  the 
case  at  bar,  there  was  no  depreciation,  and 
therefore  an  allowance  for  a  reserve  fund 
to  take  care  of  depreciation  was  not  nec- 
essary, and  should  not  be  allowed.  The 
contention  of  the  company  on  this  point  is 
that,  notwithstanding  every  part  of  a  prop- 
erly constructed  and  well-equipped  tele- 
phone system  may  be  maintained  in  good 
condition  from  year  to  year  out  of  the 
maintenance  fund,  yet  the  time  inevitably 
comes  with  every  building  and  unit  of 
equipment  when  it  can  no  longer  be  kept 
serviceable  by  repairs  or  current  mainten- 
ance, and  when  it  must  be  replaced  substan- 
tially in  its  entirety.  Therefore,  they  say, 
since  the  total  life  expectancy  of  the  parts 
of  the  entire  plant  may  be  measured  in 
years  on  something  similar  to  a  mortality 
table  basis,  unless  a  depreciation  fund  is 
provided  for  from  year  to  year  out  of  earn- 
ings, sufficient  to  replace  the  plant  substan- 
tially in  its  entirety  at  the  end  of  each  life 
expectancy  period,  the  dividends  paid  will 
before  long  represent  the  better  part  of  the 
stockholders'  investment.  A  great  many 
authorities  and  opinions  of  experts  are  cit- 
ed by  counsel  for  the  company  which  they 
say  conclusively  show  the  economic  neces- 
sity for  the  principle  contended  for,  among 
which  are  the  following:  Pioneer  Tel.  & 
Tel.  Co.  vs.  Westenhavcr,  299  Okla.,  429, 118 
Pac,  354,  38  L.  R.  A.  (N.  S.)  1209;  State 
Journal  Printing  Co.  vs.  Madison  Gas  & 
Elec.  Co.,  4  W.  R.  C,  501;  In  Re  Applica- 
tion of  Cumberland  Municipal  Elec.  Light- 
ing Co.,  4  W.  R.  C,  214;  Cunningham  et  al 
vs;  Chippewa  Falls  Water  &  L.  Co.,  5  W. 
R.  C,  302 ;  Puget  Sound  Elec.  Ry.  Co.,  vs. 
Railroad  Commission  of  Washington,  65 
Wash.,  75,  117  Pac,  739,  Ann.  Cas.,  1913, 
B,  763:  People  ex  rel  Manhattan  Ry.  Co. 
vs.  Woodbury  et  al,  203  N.  Y.,  231, 96  N.  E., 
420 ;  People  Ex  Rel.  Third  Ave.  Ry.  Co.  vs. 


77 


State  Board  of  Tax  Commissioners,  136 
App.  Div.,  155,  120  N.  Y.  Supp.,  528. 

"The  expert  opinion  relied  upon  consists 
of  an  article  by  Mr.  William  B.  Jackson, 
entitled  'Depreciation  and  Reserve  Funds 
of  Electric  Properties,'  published  in  the 
Electrical  Review  of  May  7,  1910,  page  934, 
the  report  of  William  J.  Hagenah  in  his 
investigation    of   the    Chicago    Telephone 
Company,  1910,  and  in  the  second  volume 
of  Telephony,  page  102.    After  examining 
such  of  these  authorities  as  are  available 
to  us,  and  others  on  the  same  subject  not 
cited,  we  find  ourselves  unable  to  agree 
with  counsel  in  their  assumption  that  the 
doctrine  of  depreciation,  as  contended  for 
by  them,  meets  with  the  universal  approval 
of  the  courts  and  the  economists.    From 
our  investigation  of  the  problem  of  depre- 
ciation we  are  convinced  that  precedent  on 
this  question  is  varying,  and  that  there  is 
also  great  contrariety  of  opinion  among  the 
heads  of  public  service  corporations  them- 
selves, some  companies  believing  that  their 
best  interests  lie  in  adopting  the  largest 
possible  depreciation  charge  and  in  the  con- 
sequent accumulation  of  a  permanent  fund 
in  the  future,  whilst  others  contend  that  the 
application  of  the  doctrine  amounts  to  a 
virtual  confiscation  of  their  property.  With- 
out attempting  to  set  out  herein  our  analy- 
sis of  these  discordant  views,  it  is  suffici- 
ent to  say  that  we  have  reached  the  con- 
clusion that  in  plants  of  considerable  size 
that  have  attained  their  gait,  to  which  class 
the    plant   herein   is   conceded   to   belong, 
there  is  both  theoretically  and  actually  a 
normal  condition  in  which  the  replacements 
come  along  with  comparative  evenness,  and 
where  there  can  be  no  possible  use  for  a 
so-called  depreciation  fund  of  any  consid- 
erable amount. 


78 


"In  the  case  at  bar,  as  we  have  seen,  the 
Commission  made  no  deduction,  from  the 
value  of  the  plant  on  account  of  deprecia- 
tion, but  allowed  returns  upon  its  value  as 
a  going  concern,  kept  up  to  a  high  degree 
of  efficiency  by  replacements  paid  for  out 
of  current  revenue.  There  is  no  principle 
of  public  regulation  more  firmly  established 
than  the  right  of  the  company  to  charge 
in  its  rate  an  amount  which  will  enable  it 
to  make  these  replacements,  and  as  invest- 
ors put  their  money  into  public  utilities 
for  the  sake  of  the  returns  they  will  be 
able  to  obtain,  if  the  allowance  for  replace- 
ments is  sufficient  to  keep  up  a  high  de- 
gree of  efficiency  and  prevent  a  lowering  of 
the  ability  of  the  plant  to  earn  returns,  we 
are  unable  to  perceive  the  necessity  for 
building  up  a  fund  to1  be  used  for  the  pur- 
pose of  counteracting  a  purely  theoretical 
depreciation.  The  theory  of  the  Commis- 
sion seems  to  be  that  charges  should  be 
made  in  rates  sufficient  to  counteract  or 
prevent  depreciation  by  replacements,  and 
that  when  replacements  are  thus  fully  pro- 
vided for,  depreciation  is  counteracted. 
We  see  no  error  in  this;  at  least,  none  of 
which  the  appellant  company  has  any  just 
cause  to  complain." 

The  Superior  Court  of  Pennsylvania  has  re- 
cently reaffirmed  its  decision  respecting  deprecia- 
tion in  Ben  Avon  Borough  vs.  Ohio  Valley  Water 
Company  case  (9  Pa.  Corp.  Rep.  404;  reaffd.  Id., 
P.  XJ.  R.1918  A,  page  161;  see,  also,  253  U.  S.  287), 
in  which  the  Pennsylvania  Court  said : 

* '  Depreciation,  though  largely  theoretical 
in  its  nature,  which  is  allowed  on  the  repro- 
duction cost,  seems  to  have  a  fixed  place  in 
valuation.  If,  however,  replacements  and 
renewals  are  amply  provided  for  and  made, 
depreciation  only  to   a  very  small  extent 


79 


takes  place.  If,  through  depreciation,  the 
value  of  the  property  is  largely  reduced,  the 
securities  which  were  placed  thereon  may 
be  unnecessarily  reduced  in  value.  As 
these  charges  withdraw  from  the  rate-mak- 
ing base,  such  depreciation  naturally  effects 
a  purchase  of  a  part  of  the  property  for  the 
consumer — a  thing  never  contemplated.  A 
rate  for  renewals  and  replacements  should 
be  provided  and  expended  for  that  purpose ; 
when  that  is  done,  as  is  the  custom  in  every 
utility  concern,  depreciation  is  a  very  small 
fractional  per  cent.  This  should  be  placed 
in  a  reserve,  and  it,  with  renewals  and  re- 
placements, are  properly  allowable  in  fix- 
ing a  schedule  of  rates." 

Essential  Purposes  of  the  Statute  and  the  Relation  of 
"Depreciation  Charges"  Thereto 

Looking  at  the  matter  momentarily  again  from 
the  viewpoint  of  fundamentals,  it  may  be  observed, 
at  the  risk  of  re-statement  in  part  of  something 
already  said,  that  the  objectives  of  any  sound 
treatment  of  "retirement  expense"  are  threefold: 
(1)  to  ensure  to  the  public  good,  safe  service, 
through  keeping  the  utility  property  in  good  re- 
pair and  operating  efficiency;  (2)  to  protect  the 
public  from  unlawful  and  burdensome  exactions, 
and  (3)  to  secure  to  investors  in  utility  enterprises 
a  fair  return  upon  the  property  employed  in  the 
public  service.  The  object  in  view  cannot  be  ac- 
complished unless  an  economically  sound  plan  for 
the  maintenance  of  the  integrity  of  the  property 
and  investment  through  repairs,  renewals  and  re- 
placements, be  set  up  and  followed.  The  applica- 
tion of  unsound  and  fanciful  theories  leads  to  re- 
sults most  unjust  to  all  affected.  The  public  util- 
ity is  at  all  times  entitled  to  a  reasonable  return 
on  the  fair  value  of  its  property,  and  the  user  of 
its  service  is  entitled  to  service  at  the  lowest  cost 


80 


consistent  with  efficiency  of  service,  the  defraying 
of  operating  expenses,  and  the  earning  of  a  fair 
return  on  the  investment. 

The  investment  of  money  in  public  utility  is 
made  to  serve  the  needs  of  particular  communi- 
ties, usually  a  territory  in  course  of  growth  and 
development.  Continuous  and  efficient  service  is 
demanded  and  must  be  provided.  Repairs  are 
necessary  as  portions  of  units  of  property  are 
worn  in  the  service  of  the  patrons,  and  the  expense 
thereof  must  be  currently  provided  in  the  rate. 
As  time  goes  on,  certain  items  of  property  which 
have  not  been  affected  by  use  or  wear,  may  never- 
theless be  retired  to  meet  the  growing  demands 
upon  the  system.  Some  are  retired  to  effect  econo- 
mies; others  go  out  because  larger  facilities  are 
needed  or  become  more  economical.  These  pro- 
cesses of  repair,  renewal  and  replacement  go  on 
continuously ;  their  combined  effect  is  to  perpetu- 
ate the  utility  property  as  a  going  concern.  No 
one  thinks  of  a  time  when  the  entire  plant,  struc- 
tures, machinery  and  equipment  will  be  retired  or 
go  out  of  service.  The  utility  property  is  per- 
petuated and  its  efficiency  maintained,  and  the 
expense  thereof  borne  by  the  users. 

Additions  to  the  capacity  of  the  utility,  exten- 
sions of  its  plant  and  distributing  system,  etc., 
should  of  course  be  provided  for  by  the  employ- 
ment of  new  capital  invested  by  those  having  the 
capital  to  invest  and  not  by  exactions  from  pa- 
trons. All  those  expenses  which  are  required  for 
what  are  commonly  known  as  repairs,  replace- 
ments of  wearing  parts,  etc.,  and  which  are  cur- 
rently made  in  the  every-day  operation  of  the 
system  to  make  good  the  parts  that  actually  wear 
out  in  the  service,  should  be  met  by  the  every-day 
users  of  the  utility's  service  and  provided  for  in 


81 


the  rates  charged.  The  cost  of  items  of  property 
which  are  not  worn  out  in  use,  but  which  it  may- 
become  necessary  to  retire  for  other  reasons,  such 
as  increases  in  facilities  to  accommodate  addition- 
al patrons,  or  to  effect  the  economies  made  pos- 
sible by  the  progress  of  the  art,  is  chargeable 
against  the  economies  resulting  from  such  retire- 
ment. 


Reasons  Why  the  Cost  of  Retirements  Should  Not  Be 

Anticipated  Through  Accruals  Based  on 

"Life  Tables" 

This  may  be  made  concrete  by  saying  that  out- 
side of  such  portions  of  the  plant,  equipment,  etc, 
as  are  affected  by  wear  and  tear  and  so  are  made 
good  by  current  repairs,  the  great  bulk  and  in 
fact,  substantially  all  the  major  items  going  to 
make  up  a  utility  property,  are  not  subject  to  wear 
and  tear  and  have  lives  of  indefinite  duration,  and 
are  continued  in  use  indefinitely  if  the  service  con- 
ditions presented  when  the  demand  for  service 
greatly  increases  do  not  render  them  inadequate 
or  if  economies  and  betterments  made  possible 
by  the  progress  in  the  art  do  not  make  them  ob- 
solete, even  though  still  rendering  their  original 
services  at  least  as  economically  and  efficiently 
as  when  installed.  This  increase  often  necessi- 
tates the  installation  of  larger  or  different  units 
to  meet  the  increased  demands,  but  otherwise  their 
use  goes  on.  For  example,  in  a  gas  plant  or  steam- 
generating  plant  for  electricity,  the  replacement 
of  checker  brick  in  a  gas  machine,  the  installation 
of  new  tubes  in  a  steam  boiler  or  a  condenser,  the 
repairing  of  a  meter  or  service,  the  painting  of  a 
holder  or  a  building,  the  replacing  of  a  pole,  the 
overhauling  of  a  pump  or  engine,  the  pointing 


82 


up  of  a  wall,  renewal  of  the  slate  or  shingles  on 
a  roof,  and  the  like,  are  all  matters  of  repair  which 
are  taken  care  of  in  the  everyday  operation  of  the 
plant  and  charged  to  its  operating  expenses.  In 
this  way  the  consumer  bears  his  burden  of  main- 
taining the  plant  in  condition  to  render  him  ser- 
vice. It  is  his  proper  burden  and  should  rightly 
be  borne  by  him  because  it  is  his  use  of  the  service 
that  makes  the  expense  necessary. 

But  when  the  time  comes,  if  it  ever  should  come, 
that  a  length  of  gas  main,  a  purifier  box,  a  rotary 
converter,  or  a  switchboard,  or  a  part  of  some  such 
unit,  would  need  to  be  retired,  such  expense  should 
not  be  put  upon  the  past  consumers,  because  their 
use  has  not  made  the  retirement  necessary.  Use 
has  not  lessened  the  efficiency  of  these  units  or 
created  the  conditions  of  increased  demand,  great- 
er economies,  or  progress  in  the  art,  which  lead  to 
their  retirement.  The  mere  expiration  of  time 
has  not  created  these  conditions,  which  bear  no 
relation  to  any  fanciful  "expired  portion"  of  an 
"estimated  life"  of  the  property  to  be  retired. 
The  burden  or  expense  should,  as  was  pointed  out 
in  the  opinion  in  the  New  York  &  Queens  Gas  Com- 
pany case,  quoted  from  on  pages  26  to  31,  ante,  be 
met  in  another  way  from  that  followed  as  to  cur- 
rent repairs,  and  the  only  just  way  to  meet  it  is 
by  placing  it  upon  those  who  benefit  by  the  change, 
to  wit,  the  larger  body  of  consumers,  whose  pres- 
ent and  prospective  requirements  compel  the 
change,  and  it  is  a  change  which  would  not  be 
made  were  not  the  improvements  and  economies 
effected  thereby  to  operate  to  their  benefit.  The 
expense  of  such  retirement  adds  nothing  to  the 
rate,  because  being  offset  by  economies  it  does  not 
unduly  burden  the  operating  expenses.  //  col- 
lected in  advance,  however,  it  would  mean  in- 


83 


creased  rates  to  those  who  might  never  derive  any 
benefit  therefrom. 

Concrete  Illustrations  of  the  Reasons  Why  the  Rate 

Should  Not  Be  Burdened  With  Charges 

Anticipating  Future  Retirements 

That  the  method  above  outlined  produces  a 
price  such  as  the  consumer  is  entitled  to  and  may 
demand,  and  which  does  not  overcharge  him  to 
the  advantage  of  some  future  consumer,  may  best 
be  illustrated  by  citing  a  typical  case,  which  any 
manufacturer  or  utility  would  recognize  as  char- 
acteristic of  the  business  of  producing  and  selling 
commodities  and  service : 

Smith  embarks  in  the  business  of  producing  a 
commodity.  His  machinery,  plant  and  equipment 
represent  an  investment  of  $100,000. 

He  can  produce  500,000  articles  which  will  sell 
for  ten  cents  apiece. 

His  gross  annual  receipts  are  $50,000. 

His  operating  expenses  are  $40,000. 

His  profit  is  $10,000,  or  ten  per  cent,  upon  his 
investment. 

His  investment  is  represented  by: 

Land $10,000 

Structure 60,000 

Machinery 30,000 

At  the  end  of  three  years,  he  learns  that  an  in- 
ventor has  improved  upon  the  machinery  required 
for  the  production  of  this  particular  article  and 
upon  investigation  ascertains  that  by  the  installa- 
tion of  the  new  machinery,  at  a  cost  of  $30,000,  he 
can  save  in  the  operating  expenses  $10,000  per 
annum.  The  new  machinery  is  installed  and  the 
machinery  with  which  he  began  business,  and 
which  is  as  good  as  it  ever  was,  and  which  with 
a  continuance  of  good  maintenance  he  might  con- 


84 


tinue  operating  indefinitely,  is  withdrawn  from 
service,  with  the  result  that  of  his  gross  income 
of  $50,000  there  is  now  required: 

For  operating  expenses $30,000 

For  Amortization  (3  years) . .  10,000 
Leaving  a  profit  of 10,000 

There  is  no  more  reason  than  there  was  in  the 
first  instance  for  his  speculating  as  to  the  time 
when  new  discoveries  or  inventions  will  make  it 
profitable  for  him  to  displace  his  new  equipment. 
Nevertheless,  after  the  expiration  of  another  three 
years,  he  again  learns  that  improvements  have 
been  made  by  an  inventor  in  the  type  of  machin- 
ery required  for  the  manufacture  of  his  particular 
article,  which  will  reduce  his  expenses  $10,000  per 
annum.  The  new  machinery  is  installed  at  a  cost 
of  $30,000  and  the  machinery  theretofore  used  ii 
withdrawn  from  service. 

At  the  same  time  he  is  able,  as  the  result  of  the 
first  supersession,  to  reduce  the  price  of  his  com- 
modity from  ten  cents  per  article  to  eight  cents 
per  article,  and  in  the  seventh  year  his  revenue 
statement  on  the  basis  of  selling  500,000  articles 
at  eight  cents  each,  would  be  as  follows : 

Gross  receipts $40,000 

Expenses 20,000 

For  Amortization  (3  years) . .  10,000 
Leaving  a  profit  of 10,000 

At  the  end  of  the  ninth  year,  he  has  completed 
the  "writing  off"  of  the  machinery  he  found  it 
economical  to  supersede,  and  he  reduces  the  price 
of  his  commodity  to  six  cents  per  article.  There- 
after, until  and  unless  some  further  invention 
justifies  or  necessitates  another  supersessional 
transaction,  his  annual  operations  will  be  as  fol- 
lows: 


85 


Gross  receipts $30,000 

Expenses 20,000 

Leaving  a  profit  of 10,000 

During  the  entire  ten  years,  there  was  no 
change  in  the  amount  of  his  profit.  During  the 
first  six  years  there  was  no  change  in  his  unit  sell- 
ing price.  The  cost  in  the  first  three  years  was 
his  operating  expenses  of  $40,000.  During  the  sec- 
ond three  years,  his  operating  expenses,  including 
as  a  proper  element  of  cost  the  amortization 
of  the  investment  in  the  superseded  machinery, 
were  ($30,000  -f  $10,000)  $40,000.  That  is  to 
say,  his  outlays  in  manufacturing,  distributing, 
etc.,  had  been  cut  to  $30,000  by  the  new  devices, 
but  for  three  years  he  had  to  provide  $10,000  a 
year  to  amortize  the  superseded  machinery.  After 
he  had  again  replaced  his  machinery  by  more  eco- 
nomical devices,  during  the  next  three  years  (7th, 
8th  and  9th),  his  annual  expenses  were  ($20,000 
plus  $10,000)  $30,000,  which  gave  him,  notwith- 
standing a  decrease  of  two  cents  in  the  selling 
price  per  article  of  his  commodity,  still  a  profit  of 
$10,000. 

In  the  tenth  year,  as  stated,  he  was  able  to  re- 
duce the  price  of  the  article  two  cents  more,  to  six 
cents,  reducing  his  gross  revenue  to  $30,000;  and, 
the  amortization  of  the  last  withdrawal  having 
been  completed  and  his  operating  expenses 
amounting  thereafter  to  only  $20,000,  his  profits 
continued  at  the  rate  of  $10,000  per  annum  on  his 
$100,000. 

For  the  purpose  of  presenting  the  illustration  in 
its  simplest  form,  the  elements  of  interest  in  con- 
nection with  the  process  of  amortization  and  of 
"scrap  value"  of  withdrawn  machinery  have  been 
disregarded.    The  fact  that,  in  order  to  provide 


86 


for  the  elements  of  ' '  scrap  value ' '  and  interest  on 
the  unamortized  investment  during  the  period  of 
amortization,  the  annual  enocomy  would  have  to 
be  a  little  greater,  or  smaller,  or  the  amortization 
period  a  little  longer,  or  shorter,  than  the  illus- 
tration indicates,  has  no  relevancy  to  the  principle 
involved. 

Had  this  manufacturer  been  so  misguided  as  to 
adopt  so-called  "accrued  theoretical  depreciation" 
as  a  basis  for  determining  the  cost  of  his  product 
and  had  he  possessed  actual  powers  of  clairvoy- 
ance and  been  able  to  forecast  that  at  the  expira- 
tion of  the  first  three  years  his  machinery  would 
be  superseded,  had  he  seen  fit  to  disregard  the 
fact  that  the  supersession  would  pay  for  itself  and 
undertaken  to  collect  it  in  advance,  his  selling 
price  for  the  first  three  years  would  have  been 
twelve  cents  per  article  produced,  instead  of  ten 
cents,  and  his  consumers  during  the  first  three 
years  would  have  paid  too  much  for  their  product, 
to  enable  consumers  thereafter  to  get  the  product 
more  cheaply  as  a  result  of  Smith's  putting  in 
improved  machinery  and  equipment.  Not  only 
would  Smith  have  been  robbing  Peter  (his  cus- 
tomers during  the  first  three  years)  to  pay  Paul 
(his  customers  for  the  second  three  years),  but, 
for  reasons  above  stated,  he  would  have  put  him- 
self out  of  business  altogether,  because  it  is  im- 
possible to  conceive  that  all  of  his  competitors 
would  be  guilty  of  similar  folly. 

The  "Woodpile  and  "Fleet-of-Taxicabs"  Illustrations 
As  Used  by  the  Depredationists 

The  "stock"  arguments  of  the  advocates  of 
"accrued  theoretical  depreciation"  are  predicated 
on  what  may  be  termed  the  "woodpile  illustra- 
tion" and  the  "fleet  of  taxicabs"  illustration. 


87 

These  fallacious  illustrations  were  testified  to  at 
length  by  Milo  R.  Maltbie  and  other  champions 
of  the  depreciation  theory,  in  Consolidated  Gas  Co. 
vs.  Newton,  et  al.  (see  page  32  et  seq.,  ante),  as 
well  as  in  New  York  &  Queens  Gas  Company  vs. 
Newton,  et  al.  (see  page  26,  et  seq.  ante) ;  and  so 
were  taken  up,  analyzed,  and  refuted  in  detail, 
before  the  Special  Master  in  both  those  cases.  We 
quote  from  the  resume  of  that  argument,  as  set 
forth  in  the  brief  submitted  to  Judge  Learned 
Hand  in  the  Consolidated  Gas  Company  case  (for 
his  opinion,  see  page  32  et  seq.,  ante) : 

"On  page  13,316  of  the  printed  record, 
Professor  Maltbie  confused  a  gas-plant  with 
a  wood-pile  and  gave  it  as  his  opinion  that 
the  plant  disappears  in  the  same  manner  as 
a  wood  pile  disappears  as  the  result  of  *  put- 
ting a  chunk  of  wood  into  your  stove  right 
along,  and  adds,  '  that  wood-pile  is  depre- 
ciating in  value. '  The  absurdity  of  this  il- 
lustration is  at  once  apparent  to  the  sound 
thinker.  A  gas  plant  is  not  treated  as  a 
wood-pile  is  treated.  There  is  no  analogy 
between  the  withdrawal  of  wood  from  a  pile 
and  the  operation  of  a  gas-plant.  No 
*  chunks'  of  plant  are  taken  out  and  con- 
sumed for  fuel  nor  for  any  other  purpose. 
On  the  other  hand,  if  any  part  of  a  plant 
is  taken  out  of  service  it  is  immediately  re- 
placed— otherwise  the  plant  could  not  op- 
erate. If  the  wood-pile  were  similarly 
maintained  it  would  never  diminish  either 
in  dimensions  or  in  value.  In  other  words 
the  gas-plant  is  like  a  wood-pile  to  which  a 
stick  of  wood  is  added  every  time  one  is 
withdrawn. 

"On  page  13,137  of  the  printed  record. 
Professor  Maltbie  endeavored  to  improve 
upon  the  wood-pile  analogy  by  a  clumsy  at- 
tempt to  expound  the  sophistries  by  which 
it  is  undertaken  to  demonstrate  that  a  unit 


88 


of  equipment  when  new,  produces  a  certain 
store  of  productivity  which  diminishes  pro- 
gressively during  its  period  of  life  ex- 
pectancy and  is  finally  reduced  to  zero.  He 
said,  'When  you  start  out  with  anything 
there  is  a  certain  amount  of  service  it  will 
render  and  it  has  value  because  it  will  ren- 
der that  service.  Now,  as  time  goes  on  the 
amount  of  remaining  service  which  that 
thing  will  render  decreases  as  you  go  along 
and  consequently  the  value  of  that  com- 
modity, or  article,  or  plant,  whatever  it 
may  be,  decreases  in  value  because  the  per- 
son who  owns  it  has  a  shorter  and  shorter 
time  to  get  service  out  of  that  plant  or 
anything. 

Fallacy  of  the  "Wood-pile"  Illustration 

' '  The  falsity  of  this  theory  lies  in  the  as- 
sumption that  a  gas-plant  as  a  whole,  or 
even  95  per  cent,  of  the  units  contained  in 
it,  actually  have  any  ascertainable  limit  to 
productivity.  In  other  words,  their  capac- 
ity to  produce  runs  to  infinity.  It  is  only 
what  may  be  termed  the  'wearing  parts*  of 
a  gas-plant  to  which  may  be  attributed  any 
limitation  of  their  productivity,  but  the  re- 
newal and  replacement  of  such  wearing 
parts  constitute  a  proper  item  of  operating 
cost  and  does  not  in  any  way  affect  the 
continuing  productivity  of  the  plant  as  a 
whole.  The  fact  that  the  growth  of  a  util- 
ity's business  or  the  development  in  the 
art  of  producing  artificial  gas  may  require 
that  in  the  interests  of  economy  and  ef- 
ficiency units  of  equipment,  which  would 
otherwise  last  forever,  are  displaced,  has 
nothing  to  do  with  the  productivity  of  the 
unit.  It  is  not  because  its  period  of  pro- 
ductive usefulness  has  expired  that  it  is 
withdrawn  from  service,  but  that  the  inter- 
ests of  economy  and  efficiency  may  be  con- 
served that  units  of  equipment  are  with- 


89 


drawn.  Such  withdrawals,  however,  uni- 
formly furnish  their  own  economic  justifi- 
cation. The  loss  involved  in  such  with- 
drawals if  too  large  to  charge  against  the 
revenue  for  the  year  in  which  the  with- 
drawal occurs  should  be  charged  against  the 
revenues  thereafter  until  the  loss  is  amor- 
tized out  of  the  earnings.  There  is  no  good 
nor  plausible  excuse  for  providing  for  the 
loss  involved  in  such  withdrawals  in  ad- 
vance of  their  occurring.  The  reasons  are 
several  and  obvious.  Aside  from  the  fact 
that  the  rates  paid  by  the  users  of  an  im- 
proved service  should  bear  the  burden  of 
improving  the  service  (and  this  does  not 
imply  that  it  is  ever  necessary  to  increase 
a  rate  in  order  to  amortize  the  loss  involved 
in  a  replacement  for  obsolescence  or  in- 
adequacy, for  no  instance  of  the  kind  is 
recorded),  is  the  impossibility  of  forecast- 
ing in  respect  of  what  unit  of  plant  or 
equipment  obsolescence  or  inadequacy  will 
ultimately  disclose  itself  and  the  consequent 
impossibility  of  adjusting  the  provision  to 
the  necessity — and  even  if  this  could  be 
done,  there  would  still  be  no  justification 
for  imposing  upon  the  users  of  a  given  unit 
of  plant  or  equipment  the  obligation  of  pro- 
viding in  advance  for  the  loss  involved  in 
its  ultimate  displacement  with  no  assurance 
that  the  then  rate-payer  would  ever  benefit 
by  the  transaction.  In  other  words,  an  at- 
tempt to  provide  in  advance  for  future  ob- 
solescence and  inadequacy  (which  are  the 
only  causes  for  which  units  of  plant  and 
equipment  are  displaced)  would  involve  not 
only  speculation  as  to  the  amount,  but  would 
lead  inevitably  to  a  burdensome  rate  and  to 
the  accumulation  of  a  useless  fund  which 
could  never  be  used  for  the  purpose  for 
which  it  was  alleged  to  have  been  created. 


"  Since  the  rate  for  service,  if  properly 
adjusted  to  cover  the  operating  expenses, 


90 


includes  a  fair  return  on  the  investment,  in- 
cluding the  cost  of  maintaining  the  prop- 
erty by  renewals  and  replacements  as  and 
when  necessary,  and  providing  the  amount 
necessary  to  reimburse  the  company  for  the 
loss  involved  by  renewals  and  replacements 
on  account  of  obsolescence  and  inadequacy, 
it  is  obvious  that  no  parts  of  the  plant  dim- 
inish in  value  so  long  as  they  are  in  use. 
The  amount  recoverable  in  the  rates  for  re- 
newals and  replacement  of  plant  for  ob- 
solescence and  inadequacy  is  the  amount  in 
each  case  of  the  investment  in  the  unit  of 
the  plant  or  equipment  retired.    Its  value, 
therefore,  suffers  no  diminution  or  impair- 
ment during  the  period  that  it  is  in  use.  The 
investor  buys  a  plant  which  becomes  second- 
hand the  moment  it  is  put  in  service.    The- 
oretically, it  has  lost  value,  actually  it  has 
lost  nothing,  and  the  investment  remains 
intact.     In  fact,  the  investment  is  in  the 
plant  as  it  may  be  found  at  any  time  dur- 
ing the  period  of  its  operation.    The  idea 
that  something  more  than  the  cost  of  main- 
taining it  should  be  collected  in  the  rates  in 
order   to   maintain  the  investment  unim- 
paired has  no  basis  in  fact  nor  in  eco- 
nomics.   The  absurdity  of  the  theory  that 
an  investment  in  gas-plant  becomes  pro- 
gressively impaired  and  must  be  compen- 
sated for  by  the  accumulation  of  unneces- 
sary funds  and  the  charging   of   unneces- 
sarily high  rate  for  the  service  is  best  dem- 
onstrated by  considering  the   investment 
made  in  the  distributing  system.    When  a 
company  has  removed  a  necessary  amount 
of  pavement  and  excavated  a  trench  four 
feet  deep  and  has  installed  therein  a  gas- 
main  and  has  dug  laterals  and  made  house 
connections  and  has  then  refilled  the  trench 
and  repaved  the  street-opening  and  has  ex- 
pended in  this  process  say  $1,000,000,  it  has, 
in  substance,  thrown  that  amount  of  money 
away,  except  as  the  law  recognizes  that  the 


91 


amount  invested  was  invested  in  good  faith 
to  enable  the  utility  to  render  a  service  in 
accordance  with  its  franchise  obligations, 
and  that  upon  the  amount  invested  it  is  en- 
titled to  earn  a  return  so  long  as  the  invest- 
ment remains  in  the  property  and  is  not  re- 
funded to  the  utility.  So  far  as  worth  or 
value  is  concerned,  independently  of  the 
franchise  and  the  legal  rights  of  the  com- 
pany in  the  premises,  the  buried  mains  and 
services  have  no  value  whatsoever.  It 
would  cost  a  great  deal  more  to  recover  the 
pipe  that  it  was  worth.  It  would  cost  more 
to  recover  it  than  it  cost  to  bury  it.  If  the 
questions  of  worth  and  value  are  to  be  con- 
sidered independently  of  the  question  of  the 
investment,  then  the  utility  should  collect 
from  its  prospective  consumers  the  cost  of 
installing  the  mains  and  services  before 
they  are  installed,  which  would,  of  course, 
be  impossible.  The  thing  has  but  to  be 
stated  to  disclose  the  nonsense  of  it,  and  if 
it  is  considered  that  such  an  investment 
may  be  made  by  a  gas  company  with  safety 
and  propriety,  then  there  is  no  ground  upon 
which  at  any  time  any  impairment  of  the 
investment  may  be  alleged  as  long  as  the 
mains  and  services  continue  to  perform 
their  function  of  conveying  gas  to  consum- 
ers. Every  dollar  thereafter  expended  on 
such  mains  and  services  becomes  either  a 
capital  charge  or  an  operating  expense.  If 
it  becomes  necessary,  in  order  to  meet  a  de- 
mand for  a  volume  of  gas  in  a  particular 
section,  the  necessity  for  which  could  not  be 
foreseen,  to  provide  additional  main  capac- 
ity, the  problem  would  be  whether  it  would 
be  better  to  install  an  additional  main  to 
the  one  already  in  use  and  of  perhaps  a  cor- 
responding size,  involving  the  maintenance 
and  upkeep  of  two  mains  instead  of  one,  or 
of  installing  a  single  main  of  sufficient 
capacity  to  meet  the  demand  and  withdraw- 
ing the  old  main  from  service.    The  econ- 


92 


omic  question  presented  in  such  a  case  is 
whether  to  make  an  additional  capital  in- 
vestment of  a  given  sum  and  charge  against 
the  revenue  derived  from  the  additional 
business  to  be  obtained  from  the  additional 
main  capacity  the  interest  on  the  capital 
and  the  cost  of  maintaining  the  main,  or 
of  amortizing  the  capital  investment  in  the 
old  main,  installing  a  larger  main  and  ob- 
taining from  the  earnings  of  the  larger  main 
the  amount  necessary  to  maintain  a  single 
main  instead  of  two  mains,  to  cover  the 
amortization  cost  in  the  main  withdrawn 
and  to  pay  a  return  upon  the  capital  in- 
vested in  the  single  main.  The  problem, 
when  solved  in  accordance  with  the  facts 
disclosed  in  the  particular  instance,  adds 
nothing  to  the  rates.  The  company  has  re- 
covered— probably  out  of  the  earnings  for 
the  current  year,  and  certainly  out  of  the 
earnings  for  that  and  one  or  two  subse- 
quent years — the  amount  of  its  investment 
in  the  discarded  main  and  the  entire  inci- 
dent discloses  no  ground  whatever  for  the 
accumulation  of  any  reserves  nor  for  the  ap- 
plication of  any  theory  of  depreciation. 

"The  proper  method  of  dealing  with  a 
case  of  obolescence  may  be  briefly  illus- 
trated by  citing  the  case  of  one  of  the  Con- 
solidated Gas  Company's  affiliated  com- 
panies which,  in  addition  to  doing  a  gas  and 
electric  business,  operated  a  trolley  line. 
Its  equipment  consisted  of  the  conventional 
surface  cars.  The  proposition  was  made  by 
the  engineering  staff  that  a  new  type  of  car 
known  as  the  '  one-man-car '  could  be  sub- 
stituted advantageously  for  those  in  use 
and  that  the  economies  resulting  from  the 
saving  in  the  use  of  electric  current  equired 
to  operate  the  cars  and  in  the  wages  of  one 
man,  would  suffice  to  amortize  the  invest- 
ment in  the  old  cars  within  a  period  of 
three  years.  Instructions  were,  therefore, 
given  to  dispose  of  the  old  cars  at  the  best 


93 


price  which  could  be  obtained  for  them  and 
to  charge  the  loss  involved  in  their  with- 
drawal from  service  to  a  capital  account 
entitled  "Unamortized  investment  in  care 
withdrawn  from  service;"  to  buy  the  new 
cars  and  charge  them  to  capital  account  and 
to  charge  against  the  operating  expenses 
and  credit  to  the  unamortized  investment 
in  the  old  cars  the  amount  of  estimated  sav- 
ings, so  as  to  amortize  the  balance  of  this 
account  within  a  period  of  three  years.  No 
change  was  necessary  in  the  rates  in  order 
to  effect  the  result.  This  case  is  typical  of 
what  has  been  going  on,  in  respect  of  all 
classes  of  public  service  corporations,  in- 
cluding railroads  throughout  the  country, 
for  the  last  half  century.  The  method  of 
bookkeeping  may  have  differed  and  dif- 
ferent terminology  may  have  been  used,  but 
the  substance  and  effect  of  the  transaction 
was  substantially  the  same. 

"On  page  13,335  of  the  printed  record, 
the  Master  asked:  'How  is  the  public  in- 
terested so  far  as  the  cost  of  gas  to  the 
public  is  concerned?'  and  then  after  Maltbie 
stated  that  there  is  depreciation  notwith- 
standing the  fact  that  a  plant  or  property 
may  be  rendering  sufficient  service  at  the 
time  (p.  13,336),  the  Master  said:  'He  is 
entitled  to  have  a  normally  efficient,  up-to- 
date,  economically  operated  plant,  isn't  he?' 

"It  is  to  be  emphasized  that  what  the 
Master  described  is  exactly  what  the  inves- 
tor has  put  his  money  into.  It  represents 
his  investment  unimpaired  and  undimin- 
ished by  any  theory  of  expired  life,  in  other 
words,  by  so-called  "accrued  depreciation." 

"On  page  13,377  of  the  printed  record,  in 
answering  the  Master's  question  as  to  re- 
newals and  replacements  and  their  being 
provided  for  in  the  rates,  Professor  Malt- 
bie said:  'I  cannot  see  that  they  should  be 
allowed  for  those  repairs  and  disregard  the 


94 


other'  (depreciation)  'because  the  two 
things  have  got  to  be  taken  together. '  This 
is  not  true.  They  have  not  got  to  be  con 
sidered  together  and  should  not  be  taken 
together.  The  only  provision  required  in 
order  to  continue  serving  the  public  until 
the  crack  of  doom  is  that  for  maintenance 
and  repairs,  and  nothing  else. 

The  Analogy  to  a  "Fleet  of  Buses" 

"The  witness  Maltbie  was  asked  by  coun- 
sel for  the  defendant  Newton  to  explain  in 
his  own  way  as  to  'the  value  of  depreciation 
as  applicable  to  a  bus  and  a  fleet  of  Trases. ' 
The  explanation  which  follows  furnishes  a 
striking  illustration    of   the    disingenuous 
casuistry  of  the  professional  depredation- 
ist.   He  did  not  take  a  single  bus  because  he 
knows  that  the  absurdity  of  a  computation 
applied  to  a  single  bus  would  disclose  itself 
immediately.     He  does  not  even  take  ten 
buses  and  work  out  his  depreciation  theory 
as  applied  thereto,  but  undertakes  to  make 
the  computation  more  complexed   and   in- 
volved by  assuming  that  at  the  expiration 
of  every  year  new  buses  are  added  to  the 
fleet.    To  put  the  matter  simply  and  to  show 
why  the  owner  of  a  single  bus  would  handle 
his  individual  problem  differently  from  the 
owner  of  a  fleet  of  buses  and  to  show  why 
in  neither  case,  nor  in  the  case  of  a  gas 
company,  there  is  any  excuse  for  using  a 
bogus  formula  designed  for  the  purpose  of 
finding  something  that  does  not  exist,  it  is 
only  necessary  to  explain  that  the  provident 
operator  of  a  single  taxi-cab,  who  expected 
to  continue  in  business  after  his  cab  be- 
came  inadequate    or   obsolete,   would    set 
aside  out  of  his  earnings  and  deposit  in  the 
bank  such  a  sum,  periodically,  as  would,  at 
compound  interest,  equal  the  difference  be- 
tween the  amount  he  would  be  able  to  obtain 
for  his  old  cab  and  the  amount  he  would 


95 


have  to  pay  for  a  better  one.  No  one  would 
question  his  right  to  collect  in  his  fare  the 
amount  necessary  to  provide  by  the  sinking 
fund  method  for  the  loss  due  to  the  obso- 
lescence or  inadequacy  of  his  cab  as  nearly 
as  he  could  compute  it.  No  one  would  have 
the  temerity  to  question  his  right,  in  the 
meantime,  to  collect  a  uniform  fare  for  the 
use  of  his  cab.  It  would  be  difficult  to  con- 
ceive of  a  situation  where  the  operator  of 
a  taxi-cab  would  have  to  disclose  to  a  pros- 
pective customer  the  period  of  life  expec- 
tancy of  his  cab,  the  percentage  of  such  life 
expectancy  which  had  elapsed,  and  have  his 
customer  compute  by  a  bogus  formula  call- 
ed 'straight  line  depreciation'  the  extent  to 
which  his  fare  should  be  reduced  below  that 
which  he  was  entitled  to  charge  when  his 
cab  was  new. 

"The  owner  of  a  fleet  of  ten  cabs  is  under 
no  obligation  to  increase  the  number  of  cabs 
he  has  in  service.  Tf  he  started  with  a  fleet 
of  ten  cabs  he  would  probably  have  a  great 
deal  of  trouble  during  the  first  year  in  mak- 
ing both  ends  meet.  Two  or  three  years 
would  elapse  before  his  profits  became  great 
enough  for  him  to  set  aside  in  the  bank,  at 
interest,  a  sum  designed  to  maintain  by  re- 
placements, when  necessary,  a  cab  which 
became  obsolete  or  inadequate.  By  no 
stretch  of  the  imagination  can  it  be  as- 
sumed that  his  ten  cabs  would  become  obso- 
lete or  inadequate  simultaneously,  or  that 
they  would  all  be  subjected  to  identically 
the  same  vicissitudes  of  vehicular  opera- 
tion. Furthermore,  he  would  control  his 
impulse  to  replace  his  cabs  in  accordance 
with  his  ability  to  do  so  out  of  his  earnings. 

"The  results  of  the  actual  operation  of 
his  fleet  would  probably  spread  his  cab  re- 
newals over  a  period  of  several  years,  so 
that  each  year  he  would  have  to  provide, 
out  of  his  savings  bank  fund  and  out  of 


96 


current  earnings,  the  amount  necessary  to 
replace  a  discarded  cab,  which  would  prob- 
ably be  sold  to  some  one  less  fortunate  and 
who  operated  in  a  less  exacting  district  than 
he.  With  these  financial  problems  which 
he  has  to  solve  the  public  has  no  concern. 
He  performs  his  public  obligation  when  he 
provides  transportation  at  a  rate  not  ex- 
ceeding the  statutory  limit,  with  a  cab  which 
will  hold  together  long  enough  to  complete 
the  trip.  The  fact  that  he  has  accumulated 
a  sum  in  the  bank  toward  the  replacement 
of  his  equipment,  which  might  be  large  or 
small  accordingly  as  he  is  fortunate  or  un- 
fortunate, provident  or  improvident,  could 
not  be  used  as  an  argument  in  favor  of  a 
diminution  of  the  investment  in  the  taxi- 
cabs  upon  which  he  is  entitled  to  earn  a  re- 
turn. If  he  has  set  aside  any  money  for 
this  purpose,  it  is  in  the  nature  of  a  sinking 
fund  and  the  authorities  are  perfectly  clear 
that  a  reserve  created  upon  the  sinking 
fund  basis  may  not  be  deemed  as  a  meas- 
ure of  depreciation  for  any  purpose.  It  re- 
mains to  be  asserted  by  any  one  who  speaks 
authoritatively,  or  understandingly,  that 
taxicab  fares  should  be  adjusted  to  conform 
to  so-called  'theoretical  depreciation*  com- 
puted on  the  so-called  'straight-line* 
method. 

"In  the  case  of  a  corporation  such  as  a 
gas  company,  with  plant  and  equipment 
made  up  of  units  whose  life,  except  for  ob- 
solescence and  inadequacy,  would  extend  to 
infinity,  no  reason  discloses  itself — or  ever 
has  disclosed  itself — for  the  creation  and 
maintenance  even  of  a  sinking  fund  for  the 
replacement  of  property.  As  has  already 
been  made  clear,  the  incident  of  obso- 
lescence and  inadequacy  furnishes  no  ex- 
cuse for  burdening  the  rates  for  the  pur- 
pose of  creating  reserves  against  which  the 
loss,  due  to  obsolescence  and  inadequacy, 
may  be  charged.     The  reason  is  that  the 


97 


rates,  without  such  a  burden,  are  adequate 
to  cover  the  operating  expenses  and  main- 
tain the  property  and  pay  a  fair  return  on 
the  investment  indefinitely.  The  rates 
without  such  a  burden  are  sufficient  to  take 
care  of  obsolescence  and  inadequacy  as  it 
occurs  because  the  ultimate  effect  of  re- 
placement for  obsolescence  and  inadequacy 
is  to  reduce  the  cost  and,  eventually,  to  re- 
duce the  rates. 

"It  cannot  be  alleged  in  respect  of  the  va- 
rious units  of  plant  and  equipment  of  the 
Consolidated  Company  that,  taken  collec- 
tively, they  are  in  any  worse  condition 
physically  than  they  were  ten  or  twenty  or 
thirty  years  ago,  or  at  any  other  period  in 
the  company's  history.  As  a  matter  of  fact 
they  were  never  in  better  condition  nor  ren- 
dered more  efficient  and  economical  service 
than  they  are  rendering  today,  and  their 
productivity  is  greater  per  dollar  of  in- 
vestment than  it  was  thirty,  or  twenty,  or 
ten  years  ago. 

"It  cannot  be  alleged  in  respect  of  the 
plant  and  equipment  of  the  Consolidated 
Company,  taken  as  a  whole,  that  any  cal- 
culable percentage  of  any  determinable 
period  of  life  expectancy  has  expired. 
Taken  collectively,  the  plant  will  last  for- 
ever. Its  life  may  be  perpetuated  to  in- 
finity by  the  renewal  and  replacement  of 
parts  subject  to  wear  and  tear.  Its  life, 
like  that  of  the  franchise  under  which  it  is 
operated,  is  perpetual.  It  cannot  be  alleged 
that  the  investment  in  the  plant  and  equip- 
ment of  funds  obtained  from  whatsoever 
source  is  impaired  by  any  physical  or 
economical  process,  as  for  example  by  lack 
of  newness.  The  plant  as  it  is  today  is  the 
plant  in  which  the  funds  have  been  invested. 
It  cannot  be  alleged  in  respect  of  the  invest- 
ment of  the  Consolidated  Company  that 
there  has  occurred  what  is  termed  by  false 


98 


theorists  'capital  consumption.'  Such  a 
thing  is  not  possible  in  the  case  of  a  public 
utility  like  the  complainant.  Unlike  the 
wood-pile,  the  plant  and  equipment  are  not 
consumed.  Units  of  plant  and  equipment 
are  being  withdrawn  only  to  be  replaced  im- 
mediately by  other  units,  by  which  means 
the  investment  is  kept  intact.  It  cannot  be 
alleged  that  the  Consolidated  Company  has 
accumulated  a  useless  reserve  disguised  as 
a  depreciation  reserve  or  as  a  reserve  for 
the  maintenance  of  its  property.  It  has 
been  the  Consolidated  Company's  conten- 
tion throughout  that  no  such  reserve  should 
be  accumulated ;  that  it  is  contrary  to  pub- 
lic policy;  that  the  companies  do  not  re- 
quire or  desire  it  and  that  there  should  not 
be  permitted  in  the  rates  any  such  reserve, 
since  it  involves  an  unnecessary  enhance- 
ment thereof  over  the  actual  cost  of  the  ser- 
vice, at  the  expense  of  the  consumer,  from 
which  he  derives  no  benefit.' ' 

The  Kansas  City  Southern  Case  in  the  United  States 
Supreme  Court 

It  may  further  be  pointed  out  that  if,  as  is  often 
urged,  the  Supreme  Court  intended  in  the  Knox- 
ville  case  to  hold  that  the  cost  of  superseded  prop- 
erty should  not  be  amortized  from  present  or 
future  earnings,  the  decision  in  Kansas  City 
Southern  Ry.  Co.  vs.  U.  S.  (231  U.  S.  423),  already 
referred  to  on  pages  65  and  66,  ante,  seems  explic- 
itly an  overruling  precedent.  The  major  part  of 
the  culminated  depreciation  involved  in  the  Knox- 
ville  case  arose  from  the  abandonment  of  a  water 
station  which  had  cost  a  predecessor  company 
$52,000.  Its  withdrawal  from  service  was  at- 
tributed to  the  fact  that  it  was  a  duplication  of 
plant  facilities,  and  its  use  by  the  present  com- 
pany was  no  longer  economical  or  necessary.  The 
position  of  the  company  before  the  Circuit  Court 


99 


was  that  the  amount  of  " culminated  depreciation" 
should  not  be  deducted  from  the  "rate  base"  un- 
less and  until  the  same  had  been  amortized  and 
provided  for  through  the  operating  expense  ac- 
counts (Print  202;  13th  Exception;  Point  191). 

The  Circuit  Court  sustained  this  contention. 
The  Supreme  Court,  however,  deducted  $50,000  for 
"depreciation"  from  the  figures  representing 
"reproduction  cost  new,"  but  omitted  to  add  any- 
thing to  the  expense  accounts  for  the  amortization 
of  the  sum  deducted.  In  the  Kansas  City  South- 
ern case,  nearly  five  years  later,  the  Supreme 
Court  sustained  a  rule  of  the  Interstate  Commerce 
Commission  providing  for  the  amortization  by 
way  of  charge  to  future  operating  expenses  of  the 
cost  of  portions  of  a  railway  division  withdrawn 
from  service  because  of  the  construction  of  a  new 
line  with  lower  grades  and  increased  capacity, 
holding  that  the  cost  of  property  thus  withdrawn 
from  service  should  not  remain  in  the  investment 
accounts  and  that  "abandonments  occasioned  by 
changes  of  this  character  are  therefore  chargeable 
to  future  earnings.''  (231  U.  S.  423). 

In  the  Kansas  City  Southern  case,  a  railroad 
had,  according  to  the  facts  before  the  Supreme 
Court,  been  constructed  to  meet  the  needs  of  a 
new  country  with  the  minimum  investment  neces- 
sary. As  a  result,  there  were  steep  grades.  With 
the  development  of  the  country  and  increased 
traffic  it  was  found  more  economical  to  build  a 
new  division  with  lower  grades  and  to  abandon 
parts  of  the  old  line.  '  The  company  issued  bonds, 
with  the  proceeds  of  which  it  made  the  new  con- 
struction. The  question  was  how  the  cost  of  the 
new  line  replacing  the  line  abandoned  should  be 
provided  and  paid  for.  The  Supreme  Court  said, 
at  page  451 : 


100 


"The  road  or  structures  have  to  be  re- 
placed with  stronger  or  more  efficient  in- 
strumentalities. Abandonments  occasioned 
by  changes  of  this  character  are,  therefore, 
chargeable  to  future  earnings,  for  the  rea- 
son that  the  improved  condition  of  the  road 
is  not  only  designed  to  meet  the  demands 
of  the  future,  but  presumably  will  result  in 
economies  of  operation,  and  so  the  result- 
ing benefits  will  be  reaped  by  those  who 
hold  the  stock  of  the  company  in  the  pres- 
ent and  in  the  future.    *    *    * 

"In  case,  however,  the  amount  is  so  large 
that  its  inclusion  in  a  carrier's  operating 
expenses  for  a  single  year  would  unduly 
burden  the  operating  expense  account  for 
that  year,  the  carrier  may,  if  so  authorized 
by  the  Commission,  distribute  the  cost 
throughout  a  series  of  years." 

The  Maryland  Court  of  Appeals  Rejects  "Theoretical 
Depreciation"  and  Theories  of  "Life  Ex- 
pectancy" of  Utility  Plants 

In  Havre  de  Grace  and  P.  Bridge  Co.  vs.  Tow- 
ers  (103  AtL,  319;  P.  U.  R.,  1918  D,  page  484), 
the  Maryland  Court  of  Appeals  characterized  as 
"mere  guess  work"  all  attempts  to  foretell  the 
period  of  useful  life  of  engineering  structures, 
such  as  the  radical  depreciationists  would  base 
an  accounting  system  upon.  The  Court  said  in 
part: 

"No  item  of  depreciation,  as  such,  ap- 
pears in  the  tabulation,  though  it  is  prob- 
ably intended  to  be  covered  under  the  so- 
called  'main  depreciation  reserve.'  This 
was  based  not  upon  any  direct  ascertain- 
ment of  actual  deterioration  in  the  bridge 
structure,  but  upon  the  basis  of  the  esti- 
mated future  life  of  the  bridge.  It  is  dif- 
ficult to  characterize  this  by  any  other  term 


101 


than  guess  work.  The  engineers  gave  the 
estimate  of  the  probable  duration  of  such 
bridge  from  the  time  of  its  construction. 
This  was  followed  up  by  an  estimated  dur- 
ation of  the  bridge  in  the  condition  in  which 
it  was  at  the  time  when  the  valuation  was 
made,  and  which,  if  correct,  would  show  a 
far  longer  period  of  durability  than  would 
have  been  anticipated  at  the  time  when  first 
constructed.  This  is  a  factor  which  under 
the  circumstances  of  this  case  is  in  the  high- 
est degree  speculative  and  impossible  to 
measure  in  terms  of  dollars  and  cents,  as 
the  Commission  undertook  to  do. 

"Then  superadded  to  all  of  the  consid- 
erations thus  far  noted  was  the  following: 
'We  have  given  consideration  to  the  cir- 
cumstances therein  set  up  and  have  con- 
strued them  as  creating  substantial  equities 
in  the  public  with  respect  to  the  rates  of 
toll  proper  to  be  charged  over  the  bridge 
in  question.'  Just  what  these  supposed 
substantial  equities  were  the  opinion  of  the 
Commission  throws  no  light  upon,  but  hav- 
ing them  in  mind,  and  after  the  deductions 
already  mentioned,  an  allowance,  and  ap- 
parently a  substantial  allowance,  was  made 
for  these  equities,  with  the  result  that  the 
value  of  the  bridge  was  decreased  $100,000 
and  its  value  fixed  at  $250,000,  and  the  tolls 
attempted  to  be  adjusted  so  as  to  yield  to 
the  stockholders  of  the  Bridge  Company  a 
proper  return  upon  such  valuation. 

"By  a  similar  process  of  reasoning,  it 
would  have  been  entirely  possible  to  have 
reached  any  valuation  which  might  have 
been  desired.  This  is  not  intended  as  in 
any  way  reflecting  upon  the  bona  fides  of 
the  intent  of  those  constituting  the  Public 
Service  Commission,  either  in  fixing  the 
fair  value  of  the  bridge,  or  the  rates  pro- 
mulgated by  the  Commission's  order  but 
it  is  important  as  showing  that  the  method 


102 


adopted  and  result  obtained  was  unreason- 
able. 

"It  is  not  the  function  of  this  Court  eith- 
er to  fix  the  valuation  of  the  property  or 
the  reasonableness  of  the  rates.  Its  sole 
power  and  duty  is  to  examine  those  rates 
in  the  light  of  the  method  by  which  they 
were  obtained,  and  say  whether  in  our 
judgment  the  same  were  reasonable  or  un- 
reasonable, and,  after  careful  considera- 
tion, we  are  bound  to  hold  the  action  of  the 
Commission  unreasonable,  and  the  decree 
appealed  from  must,  therefore,  be  revers- 
ed."   (Italics  ours.) 

The  Idaho  Supreme  Court  Rejects  "Theoretical 
Depreciation" 

The  fundamental  proposition  has  been  stated 
with  great  clarity  by  the  Supreme  Court  of  Idaho 
in  Murray  vs.  Public  Utilities  Commission  (150 
Pac,  57;  P.  U.  K.,  1915  F,  page  436),  in  revers- 
ing the  ruling  of  a  majority  of  the  Idaho  Commis- 
sion and  sustaining  the  contentions  made  in  the 
minority  opinion  of  Commissioner  Ramstedt  in 
the  Pocatello  Water  Company  case.  The  Idaho 
Supreme  Court  said  in  part: 

"So  far  as  the  question  of  depreciation 
is  concerned,  we  think  deduction  should  be 
made  only  for  actual,  tangible  deprecia- 
tion, and  not  for  theoretical  depreciation, 
sometimes  called  '  accrued  depreciation. '  In 
other  words,  if  it  be  demonstrated  that  the 
plant  is  in  good  operating  condition,  and 
giving  as  good  service  as  a  new  plant,  then 
the  question  of  depreciation  may  be  en- 
tirely disregarded." 

To  the  same  effect  see  Sandpoint  vs.  Sandpoint 
W.  &  L.  Co.,  P.  U.  R.,  1915  F,  page  464  (Idaho). 

The  Idaho  Public  Service  Commission  has  sub- 
sequently  rejected   the   "accrued   depreciation' ' 


103 


theory  with  great  positiveness.  The  fair  value  of 
the  property  of  the  Wood  River  Power  Company, 
an  electrical  corporation  of  Idaho,  was  fixed  by 
the  Commission,  on  January  10,  1921,  at  $312,- 
360.86.  In  arriving  at  this  value,  no  deduction 
was  made  for  accrued  depreciation.  The  Com- 
mission gave  its  reasons  for  this  as  follows  (P. 
U.  K.  1921  B,  page  531): 

"Depreciation  is  a  general  term  used  to 
cover  all  of  the  factors  affecting  the  physi- 
cal serviceability  of  a  public  utility  prop- 
erty that  cannot  and  need  not  be  currently 
met,  but  which  will  ultimately  force  retire- 
ment or  replacement.  Service  is  not  a  thing 
of  the  moment,  but  includes  the  future,  and 
the  assurance  that  service  will  be  continu- 
ous for  so  long  as  the  users  demand  and 
are  willing  to  pay  for  it.  The  assurance  of 
continuance  of  service  is  of  even  more  im- 
portance than  is  the  service  presently  ren- 
dered. Business  and  living  plans  are  made 
with  regard  to  it.  Community  and  district 
growth  are  affected  by  it,  and  it  may  be 
said  that  service  today  is  a  convenience, 
while  the  assurance  of  continuous  future 
service  is  a  necessity.  The  physical  ser- 
viceability of  a  utility's  property  means 
both  its  present  ability  to  carry  the  load 
and  its  power  of  continuing  in  service  in 
the  future.  When  the  property  is  all  phy- 
sically new  its  physical  serviceability  is  at 
its  highest  point,  but  this  new  physical  con- 
dition cannot  be  maintained.  The  passing 
of  time — age;  the  development  of  new  de- 
vices or  better  means  of  service — obso- 
lescence; the  growth  of  service  needs  in 
the  community  or  district  served— inade- 
quacy— all  of  these  contribute  to  the  de- 
terioration of  the  physical  element  of  the 
property  while  in  use.  The  effect  of  these 
cannot  be  met  or  offset  from  day  to  day 
or  year  to  year,  but  in  spite  of  repairs  and 
upkeep  cumulates  to  a  point  where  retire- 


104 


ment  or  replacement  is  necessary.  When  a 
public  utility  engages  in  the  business  of 
serving  the  public  it  assumes  a  responsi- 
bility for  keeping  its  means  of  service  in 
such  condition  that  the  service  will  not  be 
interrupted  or  impaired.  Its  property  can- 
not be  removed  and  used  elsewhere  so  long 
as  it  is  needed  in  service,  and  it  cannot  be 
permitted  to  run  down  or  get  out  of  repair 
to  a  point  where  service  is  affected.  Be- 
cause it  is  not  possible  to  meet  the  factor 
of  depreciation  from  day  to  day  or  year 
to  year,  the  full  serviceability  of  the  util- 
ity's property  can  be  maintained  only  when 
there  is  a  provision  against  the  time  when 
retirement  or  replacement  must  be  made. 
This  provision  must  necessarily  be  financial 
in  its  nature.  It  must  be  reasonably  liquid 
so  that  its  use,  when  needed,  will  not  be 
unduly  delayed ;  it  must  be  reasonably  ade- 
quate in  amount,  and  it  must  be  fully  pro- 
tected at  all  times.  From  the  nature  of 
the  obligation  which  rests  upon  the  utility 
this  provision  is  as  much  a  part  of  the  util- 
ity's property  as  any  physical  unit  in  it, 
and  when  present  it  makes  the  immediate 
physical  condition  of  the  property  unim- 
portant, as  whatever  may  have  gone  from 
the  physical  through  use  is  represented  in 
a  ready  financial  ability  to  retire  or  replace, 
when  necessary.  Serviceability  of  a  going 
public  utility  is  part  physical  and  part  fi- 
nancial, the  relative  importance  of  each  fac- 
tor being  a  matter  of  constant  change  un- 
der operation,  but  the  total  remaining  un- 
changed." 

In  Re  Campbell  Bros.  Water  Company  (case 
F-396;  Order  No.  752,  February  25,  1921),  the 
Idaho  Commission  made  no  allowance  for  "ac- 
crued depreciation' '  of  a  water  company's  prop- 
erty, where  no  "tangible  depreciation"  was  ob- 
served and  the  property  was  in  every  respect  in 
efficient  "service  condition." 


105 


The  Wisconsin  Commission  in  its  recent  cases 
has  uniformly  taken  the  position  that  depreciation 
should  not  be  deducted  in  arriving  at  a  rate  base, 
lacking  definite  proof  that  the  depreciation  has 
been  earned  and  that  it  has  been  appropriated  to 
the  investor.  Notable  among  the  decisions  of 
this  Commission  are  those  in  the  case  of  Milwau- 
kee Electric  Railway  &  Light  Company,  et  al.,  vs. 
City  of  Milwaukee,  P.  U.  R.,  1918  E,  pages  1,  27, 
and  Re  Mineral  Point  Public  Service  Company, 
P.  U.  R.,  1919  A,  page  795.  The  case  first  cited 
made  the  following  ruling  (page  27) : 

"Reproduction  cost  new  less  deprecia- 
tion can  be  used  as  the  final  measure  of 
fair  value  for  rate-making  purposes  only 
upon  the  assumption  that  the  utility  has 
not  only  earned  the  sum  represented  by  de- 
preciation in  excess  of  a  fair  return  on  the 
original  investment,  but  has  also  returned 
the  same  to  the  investors,  retaining  no  de- 
preciation reserve  represented  by  assets. ' ' 

A  similar  position  has  been  taken  by  commis- 
sions in  other  states,  the  New  Jersey  Board  of 
Public  Utility  Commissioners  having  decided,  on 
July  17,  1919,  Re  Medford  Gas  Company,  P.  U. 
R.  1919  E,  page  707,  that 

"Accrued  depreciation  should  not  be  de- 
ducted from  the  value  of  utility  propery 
for  rate  making  where  the  net  earnings  have 
not  been  sufficient  to  provide  for  it  together 
with  a  fair  return.' ' 

The  Public  Service  Commission  of  the  State  of 
Washington,  in  Public  Service  Commission  ex  rel 
the  Pacific  Power  &  Light  Company,  thus  de- 
clares its  policy  in  the  matter  of  the  deduction 
of  accrued  depreciation  in  fixing  value  for  rate- 
making  purposes  (P.  IT.  R.,  1920  F,  pages  954-57) : 


106 


"If  a  utility  has  made  a  sufficient  earn- 
ing in  the  past  to  set  aside  a  depreciation 
reserve  for  the  purpose  of  replacing  worn 
out  units,  as  occasion  required,  and  instead 
of  using  or  holding  such  reserve  for  such 
purpose,  has  distributed  the  revenues  al- 
lowed for  the  depreciation  to  its  stockhold- 
ers in  the  form  of  extra  dividends,  in  such 
case  a  regulatory  body  would  be  justified 
in  deducting  depreciation  from  the  fixed 
capital  account.  In  any  other  case,  a  de- 
duction of  the  depreciation  from  the  in- 
vestment necessary  to  render  public  ser- 
vice would  be  in  the  nature  of  confiscation 
and  would  tend  to  divert  capital  away  from 
public  utility  investment."     (Italics  ours.) 

In  Public  Service  Commission  of  Washington 
vs.  Kelso  Water  Company  (P.  U.  K.,  1919  E,  page 
206),  the  same  Commission  said: 

"We  believe  there  is  thought  worthy  of 
consideration  in  an  article  entitled  i  Theor- 
etical Depreciation,'  by  George  N.' Webster 
of  New  York,  wherein  he  states  :* 

'The  method  of  unsound  valuation 
against  which  this  article  is  directed  may 
be  described  briefly  as  the  "cost  less  de- 
preciation" method.  The  "cost"  may 
be  "original  cost,"  "average  cost,"  or 
"present  cost."  The  depreciation  which 
is  deducted  therefrom,  and  which  may 
be  said  to  have  its  origin  in  the  concept 
that  used  property  is  less  valuable  than 
new  property,  is  based  upon  the  assump- 
tion that  used  property  becomes  uni- 
formly less  valuable  during  the  period  of 
its  alleged  life  expectancy,  starting  at 
100  per  cent,  value  and  ultimately  reach- 
ing zero  value.  The  amount  to  be  de- 
ducted is  computed  by  finding  the  ratio 
of  the  expired  life  to  the  assumed  total 
life,  and  by  applying  that  ratio  to  the 


*  See  note  on  page  10.  ante. 


107 


a 


cost";  the  amount  thus  obtained,  de- 
ducted from  the  "cost,"  is  supposed  to 
represent  the  " present  value" 

•     *     • 

'It  is  not  conceivable  that  anyone  could 
give  the  subject  of  depreciation  of  the 
kind  here  illustrated  serious  considera- 
tion without  discovering  its  utter  fallacy. 
That  so  few  have  raised  their  voices  in 
protest  against  it  must  be  attributed  to 
the  fact  that  few  have  really  considered 
it  seriously.  These,  who  are  unalterably 
opposed  to  the  theory,  include  some  econ- 
omists, some  members  of  the  judiciary, 
a  few  of  the  Public  Service  Commis- 
sions, some  executives  of  corporations, 
and  some  members  of  the  legal,  engineer- 
ing and  accounting  fraternities.  They 
have  discovered  that  the  question  is  not 
one  of  engineering,  nor  of  accounting, 
but  one  of  economics  and  finance  and  the 
legal  protection  of  property  rights. '  ' ' 

In  Re  Arkansas  Light  &  Power  Company  (P. 
U.  B.  1920  D,  page  775),  the  engineer  testifying 
before  the  Arkansas  Commission,  in  behalf  of  the 
municipal  authorities,  had  filed  a  physical  valua- 
tion of  the  company's  electric  light  and  power 
plant,  based  upon  original  cost  where  the  figures 
thereof  were  obtainable  from  inquiry,  and  upon  a 
ten-year  average  of  prices  prior  to  1917,  where 
original  cost  data  was  not  available.  The  engi- 
neer then  arrived  at  a  "depreciated  value"  by  as- 
suming a  50-year  life  for  the  plant,-  and  a  17-year 
depreciation  thereof,  at  two  per  cent,  a  year,  on  a 
"straight-line"  basis.  Quoting  with  approval 
the  decision  of  the  Washington  Public  Service 
Commission  in  the  Kelso  Water  Company  case 
(see  page  104,  ante)  and  its  excerpt  from  the  Web- 
ster monograph,  the  Commission  concluded: 
"This  method  of  valuation  cannot  be  accepted  by 
the  Arkansas  Corporation  Commission,"  adding, 


108 


significantly:  "An  unwise  administration  of  reg- 
ulatory law  will  drive  capital  from  this  field  and 
bring  on  public  calamity  by  causing  the  utilities 
to  cease  to  function." 


In  Re  Gardiner  Electric  Light  db  Water  Com- 
pany (P.  U.  R,  1920  D,  page  821),  the  Montana 
Public  Service  Commission  refused  to  make  any 
deduction  from  a  valuation  based  on  actual  in- 
vestment, where  no  reserve  had  been  created  out 
of  earnings  and  the  earnings  had  been  inadequate. 
The  Commission  intimated  that  a  deduction  for 
"depreciation"  would  be  made  only  if  the  com- 
pany sought  to  claim  a  return  based  on  "  appre- 
ciation,' '  in  the  form  of  the  present  reproduction 
cost  of  its  property. 

Summary  of  Conclusions  from  Foregoing  Decisions 

The  conclusions  to  be  drawn  from  the  foregoing 
decisions  may  be  summarized  and  paraphrased  as 
follows : 

If  a  utility's  patrons  have  received  its 
service  at  a  fair  price  based  upon  actual 
cost  including  a  fair  return  on  its  invest- 
ment, and  not  at  a  price  inflated  by  the  ar- 
bitrary inclusion  therein  of,  a  provision  for 
theoretical  depreciation,  no  deduction  for 
depreciation  should  be  made  from  the  value 
of  its  property.  If  on  the  other  hand,  it 
has  been  so  misguided  as  to  accrue  "re- 
serves" on  the  "theoretical  depreciation" 
basis  and  has  exacted  from  its  patrons  an 
additional  charge  therefor,  the  amount  thus 
exacted  is  commonly  deducted  from  the 
value  of  its  property. 


109 


Basic  Objections  to  the  "Accrued  Depreciation" 
Theory 

It  is  of  course  true  that  the  practice  of  requir- 
ing reserves  for  "accrued  theoretical  deprecia- 
tion" based  on  "tables  of  estimated  lives"  of 
railroad  and  public  utility  property,  has  found  a 
measure  of  adherence  on  the  part  of  some  public 
officials  charged  with  regulatory  duties  and  also, 
in  some  instances,  on  the  part  of  executives  of 
railway  and  public  utility  enterprises.  Partic- 
ularly at  times  when  public  sentiment  was  adverse 
to  allowing  enterprises  of  this  character  to  earn 
a  rate  of  return  really  adequate,  and  the  obtain- 
ing of  money  for  new  construction  has  in  conse- 
quence been  difficult,  regulatory  officials  have  pre- 
ferred to  permit  utilities  to  fix  their  rates  on  a 
basis  of  accruing  large  "reserves"  for  so-called 
"depreciation"  and  allowing  perhaps  a  very 
meager  return  on  the  property,  over  and  above 
the  amount  of  such  reserves.  Utility  managers 
have  short-sightedly  been  willing  to  avail  them- 
selves of  this  method  of  securing  from  their  pat- 
rons a  fund  which  can  be  invested  in  new  con- 
struction, especially  where  the  net  effect  is  to  al- 
low the  utility  to  exact  from  its  patrons,  over  and 
above  actual  operating  charges  (including  the  ac- 
tual cost  of  repairs  and  the  retirement  of  prop- 
erty) a  much  more  liberal  sum  than  the  regula- 
tory officials  would  feel  it  politically  prudent  to 
allow  in  any  other  guise. 

Taking  advantage  of  this  short-sighted  view  on 
the  part  of  these  utility  managers,  propagandists 
of  radical  views,  who  are  often  found  in  the  staffs 
of  regulatory  commissions  and  sometimes  in  their 
membership,  urge  and  advocate  the  accrual  of 
still  larger  "reserves"  on  this  hypothetical  basis. 
They  know  that,  in  addition  to  giving  them  a  pre- 


110 


text  for  keeping  the  rate  of  return  down  to  a 
point  deemed  politically  prudent,  it  also  gives 
them  a  basis,  sooner  or  later,  for  asserting  two 
contentions  that  accord  fully  with  their  radical 
tenets : 

(1)  That  the  railway  or  utility  having 
accrued  a  large  "reserve"  for  "deprecia- 
tion" on  the  theory  that  a  corresponding 
part  of  the  "useful  life"  of  its  property 
has  "expired"  and  been  reduced  by  the 
flight  of  time,  and  the  amount  of  such  "de- 
preciation" in  "value"  having  been  col- 
lected, year  by  year,  from  the  rate-payers, 
the  company  cannot  be  heard  to  claim  that 
its  property  has  not  "depreciated"  in 
"present  value"  to  that  extent,  and  the 
amount  of  such  "reserve,"  invested  usually 
in  existing  property  of  the  railway  or  utili- 
ty, must  be  deducted  from  the  aggregate 
amount  on  which  the  company  would  other- 
wise be  entitled  to  have  a  fair  return  com- 
puted. 

(2)  For  similar  reasons,  whenever 
these  radical  propagandists  feel  that  pub- 
lic opinion  is  favorable  to  their  peculiar 
views,  they  loudly  advocate  governmental 
acquisition  and  operation  of  the  property, 
claiming  that  the  government  can  secure 
the  same  more  cheaply  because  the  rate- 
payers have  been  contributing  annually  to 
a  piecemeal  purchase  of  the  property, 
through  the  creation  of  a  "reserve"  that 
has  been  collected  from  them,  over  and 
above  operating  expenses  and  a  fair  return. 

Thus  the  utility  and  railway  managers  who 
countenance  the  "accrued  theoretical  deprecia- 
tion" concept,  and  the  regulatory  officials  who  ac- 
quiesce in  its  adoption,  are  lending  themselves 
to  the  confiscation  of  property  and  the  overthrow 
of  regulation.  We  submit,  on  the  basis  of  the  gen- 
eral American  experience: 


Ill 


(1)  That  the  setting  up  of  "deprecia- 
tion reserves' '  based  on  "life  tables' '  leads 
inevitably  to  an  unjust  and  burdensome  in- 
flation of  the  rate  charged  to  patrons  and 
to  the  accrual  of  reserves  vastly  greater 
than  are  actually  necessary  to  make  provi- 
sion for  the  retirements  of  property  as  and 
when  they  occur. 

(2)  That  when  reserves  are  set  up  and 
accrued  on  this  basis,  the  amount  of  such 
reserves  constitutes  the  minimum  amount 
which  is  sooner  or  later  deducted  from  the 
sum  on  which  the  company  would  otherwise 
have  its  fair  return  calculated,  and  would 
in  any  event  be  deducted  from  the  sum 
which  the  government  would  pay  for  the 
property  upon  any  acquisition  of  the  same. 

(3)  That  this  deduction  is  made  in  com- 
plete disregard  of  the  fact  that  even  in- 
cluding the  net  balance  in  such  reserves  as 
a  part  of  the  sum  earned  by  the  enterprise 
over  and  above  actual  operating  charges, 
the  aggregate  figures  still  constitute  less 
than  the  fair  return  which  the  enterprise 
was  constitutionally  entitled  to  earn  upon 
the  fair  value  of  its  property. 

(4)  That  where  the  matter  of  retire- 
ment expense  is  treated  in  a  sound  way,  on 
the  basis  of  actual  outlays  therefor,  charg- 
ed against  operating  expenses,  none  of 
these  confiscatory  consequences  rise  up  to 
plague  the  enterprise  and  deprive  its  in- 
vestors of  their  constitutional  rights. 

Maintenance  of  Utility  Property  Matter  of  Physical 

Performance  Under  Commission  Regulation, 

Not  of  Reserves  or  Accounting 

Reserves  for  depreciation  are  justified  by  their 
advocates  on  the  ground  that  such  reserves  should 
be  created  and  maintained  in  order  to  insure  a 
proper  upkeep  of  the  property  which  would  other- 


112 


wise  be  allowed  to  sink  into  a  condition  of  unre- 
pair and  inefficiency.  This  is  altogether  unfound- 
ed. A  reserve  represents  a  fund  not  yet  expended 
for  the  purpose  for  ivhich  it  was  created.  The 
mere  existence  of  a  reserve  is  no  evidence  that  the 
thing  for  which  it  is  created  has  been  done  or  will 
be  done.  Bien  au  contraire.  To  attach  any  such 
significance  to  a  reserve  is  to  exalt  form  over  sub- 
stance. The  very  purpose  of  the  regulation  of 
public  utilities  is  not  to  create  reserves  but,  to  see 
that  service  is  safe  and  adequate,  and  rendered  at 
reasonable  rates.  The  power  and  duty  of  the  reg- 
ulating body  is  to  see  to  it  directly  that  service  is 
rendered  which  conforms  to  statutory  require- 
ments and  that  the  plant  and  equipment  is  main- 
tained by  repairs  and  renewals  and  replacements 
in  a  condition  to  render  such  service.  Specific 
powers  are  given  the  Commission  to  order  repairs, 
replacements  and  betterments.  (Pub.  Serv. 
Comn.  LaAv,  Sees.  65,  66).  Power  to  require  a 
''depreciation"  reserve  has  not  been  conferred 
(People  ex  rel  New  York  Rys.  Co.  vs.  Pub.  Serv 
Comm.,  223  N.  Y.  373).  Securing  the  safety  and 
adequacy  of  facilities  and  service  is  a  matter  ol 
physical  performance,  not  of  reserves  or  account- 
ing— of  fact,  not  of  theory  or  formula. 

The  Brooklyn  Borough  Gas  Company  Case  and  Other 
New  York  Rulings 

The  decision  of  Ex-Justice  Charles  E.  Hughes, 
as  Referee  in  Brooklyn  Borough  Gas  Company  vs. 
Public  Service  Commission  for  the  First  District 
(17  State  Dept.  Rep.,  81,  103,  104),  is  sometimes 
claimed  as  a  precedent  for  a  deduction  of  "ac- 
crued depreciation"  from  the  reproduction  cost  of 
property.  In  that  case,  the  distinguished  Referee 
simply  deducted  from  the  reproduction   cost    of 


113 


the  property  as  found  by  a  decision  and  order  of 
the  Public  Service  Commission  and  as  entered  by 
the  Company  in  its  fixed  capital  accounts,  pur- 
suant to  such  order,  as  the  book  value  of  its  prop- 
erty, the  amount  which  the  company  itself,  like- 
wise in  pursuance  of  such  order,  carried  in  a  gen- 
eral reserve  account  entitled  "Accrued  Amortiza- 
tion of  Capital."  When  the  municipality  pre- 
sented elaborate  tables  showing  an  estimate  of 
"accrued  depreciation"  on  a  "life  table"  basis, 
the  company  said  that  the  amount  of  "deprecia- 
tion on  its  property  was  the  amount  remaining  in 
this  reserve."  This  sum  the  Eeferee  deducted  as 
representing  the  "total  extent  of  accrued  depre- 
ciation according  to  the  plaintiff's  estimate." 

The  distinguished  Referee  observed  that: 

"There  is  no  evidence  whatever  to  im- 
pugn the  correctness  of  this  estimate  of  the 
accrued  depreciation  or  of  the  propriety  of 
the  annual  additions  to  the  depreciation  re- 
serve, or  the  correctness  of  the  total  esti- 
mate of  accrued  depreciation  by  the  account 
known  as  'accrued  amortization  of  capital* 
as  it  stood  on  December  31,  1917." 

The  Referee  stated  the  basis  of  his  action  to  be 
that: 

"There  is  simply  deducted  the  amount  of 
its  own  estimate  of  the  accrued  deprecia- 
tion in  its  plant  (17  State  Dept.  Rep.,  81, 
103)." 

It  will  be  observed  that  there  was  nothing  in 
Justice  Hughes '  opinion  in  this  case  or  in  the  Min- 
nesota Rate  Case  which  justifies  a  reference  to 
them  as  "strongly  supporting"  the  "accrued  the- 
oretical depreciation"  claim.  The  reverse  is  true. 
In  the  Brooklyn  Borough  case,  the  defendant 
authorities  had  presented  elaborate  tables  of  "ac- 


114 


crued  theoretical  depreciation,"  prepared  by  Mr. 
Alton  D.  Adams.  This  theory  of  the  case  and 
these  tables  the  Referee  rejected  and  based  no 
deduction  upon  them.  He  deducted  only  the 
amount  of  "depreciation"  at  that  time  admitted 
by  the  Company  itself! 

The  New  York  Public  Service  Commission  for 
the  Second  District,  while  following  Judge 
Hughes'  view  that  the  reserve  must  be  deducted 
where  the  company  has  itself  created  such  a  re- 
serve, ruled  recently  that  when  no  "depreciation 
reserve"  has  been  created  by  the  Company,  no 
deduction  for  depreciation  should  be  made  from 
fixed  capital  If  the  Company  itself  creates  and 
carries  on  its  books  such  a  reserve,  the  Com- 
mission held  that  the  amount  thereof  is  of  neces- 
sity deducted  by  the  State  regulatory  body  in 
arriving  at  the  quantum  of  property  investment 
upon  which  the  company  is  entitled  to  earn  a  re- 
turn. In  Complaint  against  Binghamton  Liaht, 
Heat  &  Power  Company,  (24  State  Department 
Reports,  651,  at  page  655),  the  Public  Service 
Commission  for  the  Second  District,  in  a  unani- 
mous opinion  by  Commissioner  Irvine,  held: 

"The  company  has  failed  to  set  aside  as 
a  depreciation  reserve  as  much  as  was  rec- 
ommended by  the  Commission  in  a  capital- 
ization case  in  1916.  Its  books  now  show  a 
reserve  of  $170,830.67.  The  books  indicate 
that  this  has  all  been  reinvested  in  plant 
and  should,  therefore,  be  deducted  from 
fixed  capital  in  obtaining  a  rate  base.  It  is 
claimed  that  the  deduction  should  be  on  the 
basis  recommended.  While  the  Court  of 
Appeals  has,  in  a  case  relating  to  this  very 
company,  emphatically  declared  the  neces- 
sity of  such  a  reserve  (People  ex  rel.  B.  L. 
H.  &  P.  Co.  vs.  Stevens,  203  N.  Y.  7)  it 
has  also  declared  that  the  Commission  is 


115 


without  power  to  impose  upon  a  corpora- 
tion any  specific  requirement  therefor 
(People  ex  rel.  N.  Y.  R.  Co.  vs.  P.  S.  C, 
223  N.  Y.,  373).  As  the  Commission  may 
not  directly  impose  such  a  requirement  it 
would  seem  that  it  may  not  indirectly  do  so 
by  charging  arbitrarily  against  the  fixed 
capital  a  non-existent  reserve  sufficient  to 
meet  its  ideas  of  what  should  properly  have 
been  set  up.  Nothing  has  been  taken  from 
the  public  on  this  account  beyond  the 
amount  actually  set  up  and  there  has  been 
no  obsolescence  or  retirement  decreasing 
the  efficiency  of  the  plant  or  not  reflected  in 
credits  to  fixed  capital.' ' 

See,  also  Hoffman  vs.  Elmira  Water,  Light  & 
Railroad  Company  (N.  Y.  Pub.  Serv.  Comn.,  2nd 
Dist.;  January  22,  1920;  P  .U.  R,  1920D,  page 
266;  Ibid,  P.  U.  R,  1921C,  page  409;  Re  New 
York  State  Railways  (N.  Y.  Pub.  Serv.  Comn.,  2nd 
Dist.;  P.  U.  R,  1921C,  page  496).  In  both  the 
cases  last  cited,  the  Commission  refused  to  de- 
duct "accrued  depreciation* '  from  the  "original 
cost"  of  the  utility  property,  but  based  such  ac- 
tion, at  least  in  part,  on  a  finding  that  the  "pres- 
ent value"  of  the  property  was  at  least  the  invest- 
ment therein,  without  deduction. 

In  Amherst  vs.  Snyder  Gas  Co.  (P.  U.  R,  1921D, 
page  540),  the  New  York  Public  Service  Commis- 
sion held: 

"The  company  has  on  its  books  a  reserve 
for  accrued  amortization  of  capital  of  $7,- 
085.94.  The  record  shows,  however,  that  it 
has  not  earned  a  full  return  upon  its  actual 
investment.  This  reserve  has  been  accumu- 
lated from  funds  which  would  otherwise 
have  been  properly  available  for  dividends. 
It  has  been  contributed  by  the  stockholders 
and  not  by  the  rate  payers.  It  should, 
therefore,  not  be  deducted  in  this  case  in 
arriving  at  a  rate  base." 


116 


In  Re  Rates  of  Katonah  Lighting  Company,  de- 
cided by  the  present  Public  Service  Commission 
of  New  York  State  on  July  14, 1921,  the  Commis- 
sion, through  Commissioner  Semple,  laid  down 
the  rule  as  follows: 

"The  company  as  of  December  31,  1920, 
reports  a  reserve  for  accrued  amortization 
of  capital  of  $17,324.16.  A  study  of  the  rec- 
ord indicates  that  the  company,  during  its 
existence,  has  not  earned  a  full  return  upon 
its  investment  and  that  the  reserve  repre- 
sents purely  a  book  figure  and  has  not  been 
contributed  by  the  rate  payers.  It  should 
therefore  not  be  deducted  in  this  case  in 
arriving  at  the  rate  base 


•  •  •  >> 


In  other  words,  in  ascertaining  the  so-called 
"rate  base,"  the  making  of  a  deduction,  even  of 
the  amount  of  a  "depreciation  reserve  actually 
accrued  on  the  company's  books"  from  the  invest- 
ment is  regarded  as  warranted  only  if  it  appears 
(1)  that  the  utility  has  earned  in  addition  to  such 
reserve  enough  to  yield  it  a  fair  return  over  and 
above  operating  expenses,  including  the  cost  of 
maintaining  its  property;  and  (2)  that  the  utility 
has  nevertheless  failed  to  repair  and  maintain  its 
property  and  has  permitted  its  productivity  and 
service  condition  to  deteriorate  through  such  fail- 
ure. No  deduction  at  all  from  the  book  investment 
was  made  by  the  New  York  State  regulatory  body 
on  any  theory  that  any  percentage  of  the  "service 
life"  of  the  utility's  plant  and  property  had  al- 
ready expired. 

In  Conclusion 

The  adoption  of  theoretical  depreciation  as  the 
basis  of  the  provision  to  be  made  by  common  car- 
riers for  the  "depreciation"  referred  to  in  the 


117 


Act,  finds  no  justification  in  sound  principles  of 
economics  or  finance.  Its  adoption  would  be  con- 
trary to  public  policy  and  would  do  more  to  de- 
stroy public  confidence  in  railroad  securities  than 
any  other  suggestion  that  has  come  from  the  camp 
of  those  at  heart  opposed  to  private  ownership 
and  operation  under  adequate  public  regulation. 
If  enforceable,  it  would  wickedly  burden  railroad 
rates  with  a  fictitious  expense  when  they  are 
already  overburdened  with  legitimate  operating 
expenses  compelling  rates  so  high  as  to  menace 
the  industries  and  commerce  of  the  country.  It 
would  in  effect,  be  to  play  into  the  hands  of  Fed- 
eral ownership  fanatics  at  a  time  when  the  people 
have  unqualifiedly  placed  their  disapproval  on 
governmental  ownership  and  have  retired  its 
strongest  advocates  from  office.  We  protest, 
therefore,  that  the  Interstate  Commerce  Commis- 
sion would  have  no  right  or  reason  to  put  the  seal 
of  its  apparent  approval  upon  a  theory,  which, 
if  carried  to  its  logical  conclusion,  would  result 
in  the  virtual  confiscation  of  billions  of  dollars  in- 
vested in  railroad  property,  this  being  the  real 
aim  and  purpose  of  the  proponents  of  this  theory. 
Nor  would  the  Commission  be  warranted  in  adopt- 
ing a  theory  against  which  virtually  every  Court, 
regulatory  commissioner,  economist  and  financier, 
who  has  given  it  careful  and  thorough  considera- 
tion, has  ruled  unqualifiedly,  and  which  the  Com- 
mission may  not  legally  enforce  after  it  has  adopt- 
ed it.  We  protest  against  any  action  by  this 
Commission  giving  to  this  obsolete  and  discredited 
theory  any  manner  of  support. 

When  the  question  of  the  form  and  substance 
of  the  regulations  to  be  prescribed  under  Section 
20  reaches  the  stage  of  discussion  and  hearing  by 
and  before  the  Commission,  we  shall  be  glad  to 
be  advised  of  any  opportunity  to  participate  in 


118 


such  a  discussion,  to  the  end  that  no  fictitious  in- 
clusions in  the  operating  expenses  of  carriers  may 
be  permitted  to  augment  avoidably  the  transpor- 
tation costs  which  our  companies  must  in  turn 
pass  on  to  their  many  consumers. 

Respectfully  submitted, 

ROBERT  A.  CARTER, 
WILLIAM  L.  RANSOM. 


